|So, you want to
by Bean Counter's Dave Marshall
|Introduction||Lesson 1||Lesson 2||Lesson 3||Lesson 4||Lesson 5||Lesson 6|
|The General Journal is used to
record unusual or infrequent types of transactions. If a
transaction doesn't "fit" in any of the other special journals then
record it in this journal.
In some prior lessons we've been using it to record all of our transactions, but that is not what it is actually intended to do. We've been using it as a teaching or learning tool in order to become familiar with analyzing transactions, learning about debits and credits, and posting to the General Ledger.
In the "real" bookkeeping world, the Special Journals are used to group and initially record similar transactions and the General Journal takes care of any other transactions that need to be recorded.
OK, so let's take a look and discuss what type of transactions are normally recorded in the General Journal. In prior lessons, we used a service business XYZ Cleaning to illustrate what records to use and how to record different types of business transactions. In this lesson we're going to use a business, Shabby Computer Systems, that not only sells services but also sells products.
At the end of an accounting period (month/year), the account balances are brought up to date and amounts are adjusted to reflect their current correct balance with general journal entries that are called adjusting entries.
Types Of Adjusting Entries
Closing Entries are made at the end of a period (usually year) to reduce the "temporary" account balances (revenue, expenses, and drawing accounts) to zero and transfer the summarized balances to the capital account. Closing entries only affect the Income Statement Accounts and the Owner's Drawing and Capital Account. We reset our income statement account (revenues & expenses) balances to zero in order to start over and begin calculating the results for the next new period. If we didn't, the new period would have, not only the results from the new period, but also the results from the prior (older) period included.
Let's revisit some old Definitions, Rules, and Concepts and learn some new needed for this lesson.
Assets-the Unexpired (not used up) Cost or Value of the properties used in the operation or investment activities of a business.
Expenses-Costs of goods and services consumed (used up/expired) in the operation of a business.
Revenue- Amounts a business earns by selling services and products. Amounts billed to customers for services and/or products.
Liabilities- Claims by creditors to the property (assets) of a business until they are paid.
Matching Concept-Recording the revenues earned during a period and matching (offsetting) the revenues with the expenses incurred in generating this revenue.
Accrual Basis-Records income in the period earned and all expenses in the period incurred.
Periodic Inventory System-Simple method for keeping up with products and calculating the cost of products that were sold in a period. An actual count is periodically performed in order to determine the value of the inventory.
Perpetual Inventory System-Method for keeping up with products and calculating the cost of products that were sold in a period. Up-to-date inventory records are maintained at all times. A detailed record is maintained for each product that keeps up with the quantities and cost of each purchase and the quantities and cost associated with each sale. An actual count is usually done at the end of the year in order to check the accuracy and correct any errors in the detailed records.
Purchase Account/Cost of Goods Sold/Inventory Accounts-General Ledger Accounts used to help keep up with products and aid in calculating the cost of products sold.
Prepayments-Expenditures made in a period which are not charged to a period expense account until they are used up. The expenditure is originally recorded as an Asset and charged to a period's Expense Account when a portion or all of the benefit has been used.
Trial Balance-A worksheet listing of all the accounts appearing in the general ledger with the dollar amount of the debit or credit balance of each. Used to make sure the books are "in balance" -total debits and credits are equal and use as an aid in recording adjusting and closing entries.
Depreciation-Expired portion of an Asset's (equipment used in a business) Original Cost. The logic behind the concept is quite simple. If you purchased a piece of equipment for $100,000 in a month, the expenditure provides benefit to not only the current month, but also future months and even future years. The cost (expenditure for the equipment) is originally recorded as an Asset and and charged to a period's Expense Account when a portion or all of the benefit has been used.
Temporary Accounts (also called Nominal Accounts)- Revenue, Expense, and Drawing Accounts. Closed to capital account at the end of the period.
Income Summary Account-Special Temporary "Equity" Account used for closing and transferring our Revenue and Expense Account ending balances. We could close out our income and expense accounts for the period by transferring the account balances directly to our Capital Account (Owner's Equity). Instead we use this Special Account as an "informal income statement" and only transfer one summary amount to our Capital Account. The difference between the debit and credit balance in our Income Summary Account is actually profit if the credit balance accounts (sales/revenue) are greater than the debit balance accounts and a loss if the debit balance accounts (expenses) are greater than the credit balance accounts.
All our prior lessons have dealt with companies that only provided services.
In this and future lessons, we're going to use Shabby Computer Systems a sole proprietorship owned by Smart Computerguy that provides services and products. They not only sell consulting services but also computers and computer accessories.
Our Assumptions and Other Events
Assumptions and other events to use in adjusting and closing our books are as follows:
Discussion of Our Adjusting Journal Entries
Clicking on the Underlined Worksheet Link takes you to the first entry for our transaction in our Worksheet. You can easily determine all the accounts affected by the transaction in the worksheet by matching the reference number of the transaction to all the accounts affected. All the accounts affected will have the same reference number.
Let's use Entry Number (1) as an example. Entry Number (1) has an Underlined Link for the first entry which affects the Account Office Supplies Inventory and another Entry Number (1) Reference to the Account Office Supplies Expense without a link. All the Reference Number (1)'s are accounts affected by the transaction.
To Return Click on the Underlined Reference Number of the Entry (1), (2), etc. in our Worksheet.
Let's get started reviewing and discussing each adjusting entry. The Type of Adjusting Entry and the Accounts Affected are taken from our earlier Table.
Office Supplies Inventory had a beginning of the year balance of $500. Purchases of an additional $1000 were made during the year and charged directly to the Office Supplies Inventory Account which resulted in the ending balance of $1500 in the Trial Balance. We counted and valued the actual office supplies we had on hand at year end. The ending value of the actual count was $300.
Type of Adjusting Entry:
Inventory / Expense Accounts
Office Supplies actually appear in our financial statements as two type of accounts. One is the Office Supplies Expense Account and the other is our Office Supplies Inventory Account. During the year we have two options for initially recording our office supplies:
Ok let's do it for our example !
The current balance in our Office Supplies Inventory Account in our Trial Balance is $1,500. We need to adjust this balance to our actual balance which is $300 (based on our actual count). We do this by reducing our Office Supplies Inventory (Credit) 1,200 and charging our Office Supplies Expense Account (Debit) 1,200.
You don't have to be a rocket scientist to do this simple calculation. A little logic and common sense will do quite nicely. We first calculated the Total Amount To Account For by adding our Beginning Inventory and Purchases for the period. If we didn't use any office supplies this would be our ending value. We know; however, that we used some of our office supplies during the period. We therefore subtract out what we have left (ending inventory) in order to determine what we used.
Think of a fresh baked pie cut up into 8 slices (total to account for). We come back later and count the pie slices that are left. We find that we have 3 slices left (ending inventory). How many were used (eaten) ? Of course 5 slices were used (eaten). The same logic and common sense applies to our business example and is what the periodic inventory system is based on.
Our adjusting entry using Option 1 is an increase in our Expense Account Office Supplies (Debit) for $1, 200 and a decrease in our Asset Account Office Supplies Inventory (Credit) for $1,200.
What about Option 2 recording all our initial purchases in the Office Supplies Expense Account ? I'm sure you're familiar with the ole saying that there's more than one way to skin a cat. If we had used Option 2 during our period our Office Supplies Expense Account would have had an ending balance of $1,000 and our Office Supplies Inventory Account would still have that balance that it began the period with $500.
Since the current balance in our Office Supplies Inventory Account in our Trial Balance is $500. We need to adjust this balance to our actual balance which is $300 (based on our actual count). Since we need to decrease this balance, we'll credit Office Supplies for $200 and increase (debit) Office Supplies Expenses for $200. After posting these adjustments the ending balance in the Office Supplies Inventory Account is $300 (500-200) and the ending balance of our Office Supplies Expense Account is $1,200 (1000+200). By golly we end up with the same balances regardless of which method we use during the period.
If we had used Option 2 for recording our Office Supplies Inventory and Office Supplies Expenses we would have the following adjusting entry. Our adjusting entry using Option 2 is an increase in our Expense Account Office Supplies (Debit) for $200 and a decrease in our Asset Account Office Supplies Inventory (Credit) for $200.
Either option for your initial recording of your purchases is acceptable. Choose the one you're more comfortable with.
We totalled our Accounts Receivable Subsidiary Ledger and the balance agreed with our Accounts Receivable Control Account. They both totalled $25800. We also reviewed all of our customers and found that one of our customer accounts Joe The Dead Beat who owed us $1000 was very past due and had bankrupt
Type of Adjusting Entry:
Unfortunately, your business will occasionally have a customer like Joe The Dead Beat who can't or won't pay his bill. Our total amount due from all our customers is $25,800; however, Joe owes us $1000 of the total. Since we won't be able to collect this $1000, we need to adjust our accounting records. Since we have a Control Account Accounts Receivable and an Accounts Receivable Subsidiary Ledger Account we need to adjust both the total amount included in the Control Account in our General Ledger and Joe's Account in the Subsidiary Ledger. Our asset account Accounts Receivable needs to be decreased by a $1000 . Should this part of the transaction be recorded as a debit or a credit ? I hope you said credit. The other account affected is bad debt expense which needs to be increased by $1000. As you know by now, an increase in an expense account is recorded as a debit.
We reviewed our insurance coverage and found that our premium for coverage for our entire year was $6000. The policy runs from January-December and we paid the full amount for the coverage in January.
Type of Adjusting Entry:
Some costs/expenses that a business incurs provide benefit over an extended period of time. These type of expenditures are called Prepayments (Asset Account). In our example we paid $6000 in January for coverage that actually provided insurance coverage benefits to each month during our year. We did a pretty good job by initially recording this transaction in our Asset Account- Prepaid Insurance; however, we were a little lax by not recording a portion of the expense in each month during our year.
What should we have been doing at the end of each month to accurately reflect the benefit of our insurance coverage provided to each month? Let's see.
We should have been making this adjusting entry at the end of each month during our year. Shame on us. So what are we going to do now ? Actually, we should go back and adjust each month but I'm going to be kind and let us only make one adjusting entry for the entire year and record the total insurance expense in the month of December. Won't this distort our books ? Yes and no. Our totals for the year will be correct but December's profit/loss will be overstated by 5,500 and each of our other month's profit and loss will be overstated by $500. Since we now know better, next year we're going to properly handle our prepayments.
Adjusting Entry for this year.
Food for thought. What if we paid the premium of $6000 for a years worth of coverage at the beginning of July and our policy ran from July of this year till the end of June of the next year ?
Our monthly benefit would still be $500 ($6000/12) but only $3000 of our insurance coverage would be used up in our current year (July-December=6 months @ $500/per month) and the other $3000 (January-June=6 months @ $500/per month)would be used up during our next year.
If this were the case what ending balance would our Prepaid Insurance account have ? Our Prepaid Insurance Account would have an ending balance of $3000 that represents the future benefits of our insurance coverage (Total Policy Amount $6000 less 6 months of coverage @$500 per month).
Our Inventory for Resale is made up of all our computers, monitors, and printers. The balance in the Trial Balance is the balance as of the beginning of our year and was based on our prior year's count. We received our current year's count from our warehouse and arrived at a value (cost) of $8000 as of December 31, xxxx. Our purchases account in our trial balance shows that we purchased $70,000 worth of computer equipment during the year.
Type of Adjusting Entry: Inventory / Cost &
In our prior examples, we've dealt with service types of business that only sold services and did not sell any products. Not only is this example intended to illustrate an adjusting entry, but also to provide a brief introduction into how to account for and keep up with products and their costs.
Lets review a couple of definitions that were introduced earlier and add a few new ones.
Periodic Inventory System-Method for keeping up with products and calculating the cost of products that were sold in a period. An actually count is periodically performed in order to determine the value of the inventory.
Purchase Account/Cost of Goods Sold/Inventory Accounts-General Ledger Accounts used to help keep up with products and aid in calculating the cost of products sold.
The Purchase Account is an account used only to record the cost of merchandise bought to be sold to your customers. Items that are purchased for use in your business such as office supplies and maintenance supplies are charged directly to an Inventory or Expense Account. See Adjusting Entry (1) for an example. The Purchase Account is a temporary account that is adjusted at the end of an accounting period (month/year). Actually, you could record your Purchases of Products for Resale directly in your Products For Resale Inventory Account but by using the Purchases Account it provides you with a quick total of the amount you spent buying products during a period. Since purchasing products to sell is probably the biggest expenditure a business that sells products will incur during a period (month/year), we accountants (bean counters) feel it is worthy of an account of its own named Purchases.
The Cost Of Goods Sold is a special account that records the cost of the goods that were sold to your customers. If the Periodic Inventory System is used, this Account is adjusted with an adjusting journal entry.
difference between your Sales and your Cost Of Goods Sold is
referred to as your Gross Profit.
Of course your Inventory for Resale Account represents the quantities and value (cost) of the goods on hand and available for resale.
Let's use a Simple Worksheet to help us see how all the pieces fit together and as an aid for preparing our adjusting entries.
Does this worksheet look a little bit familiar ? It should we used a very similar worksheet to account for our Office Supplies in our Adjusting Entry (1).
Using our worksheet as a guide, let's prepare our adjusting entries. We'll make two journal entries in order to help us understand what is going on.
The first entry will transfer the balance from our Purchases Account to our Inventory For Resale Account.
The second entry will adjust our Ending Inventory Balance in our Inventory For Resale Account and record our Calculated Cost Of Goods Sold amount in our Cost Of Goods Sold Account.
The actual entry we made combined all the entries that affected Inventory / Purchases / Cost Of Goods Sold accounts into one entry. This is what is called a Compound Entry. A compound entry is just an entry that contains more than one debit and one credit.
No big deal, we just combined all the entries into one Adjusting Journal Entry instead of two.
As I stated earlier, my objective was to introduce accounting for Product Inventories and you need to seek additional learning materials and guidance to fully understand all the ins and outs of properly accounting for Inventories.
We reviewed our bank statements for the year and found that we had failed to record our monthly bank charges. The total of the charges for the year was $240.
Type of Adjusting Entry: Bank Charges &
Each month you or your bookkeeper should prepare a Bank Reconciliation to double check that all checks, fees, and deposits have been properly recorded in your books. Some entries such as fees for checks and monthly account charges have been recorded by your bank but often have not been recorded in your books. These fees need to be recorded with a journal entry in your General Journal. Although we're only going to make one adjusting entry for the entire year, these fees should be recorded with an adjusting entry each month. Can you think of another type of bank charge that we want to avoid but does occur in the "real" world ? Yeah, those customers that send us checks and don't have the money in the bank to cover them cause us to be charged a bad check processing fee by our bank and additional work in trying to collect them.
Our entry that we need to record is a decrease in our Asset Account Cash (Credit) for $240 and an increase in our Expense Account Bank Charges (Debit) for $240.
The only property or equipment we have is a brand new delivery truck. The cost of the truck was $15,500 and is the amount shown in the Trial Balance Column. The truck was purchased at the beginning of January and we feel that we'll get 5 years of use from this vehicle.
Type of Adjusting Entry: Fixed Assets
Let's first review our definition of depreciation. Depreciation is the expired portion of an Asset's (equipment used in a business) Original Cost. The logic behind the concept is quite simple. If you purchased a piece of equipment for $100,000 in a month, the expenditure provides benefit to not only the current month, but also future months and even future years. The cost (expenditure for the equipment) is originally recorded as an Asset and charged to a period's Expense Account when a portion or all of the benefit has been used.
In our example, we purchased a Truck for $15,500 in January. How much benefit from the truck do we receive in each year ? Since this is only an introductory tutorial, we're not going to explore all the different methods and rules for calculating depreciation. We're going to use what is called the Straight Line Method to calculate our depreciation expense.
We'll use the formula for the straight line method to calculate our depreciation.
Based on our calculation we receive a benefit of $3100 per year for the use of our truck. This is the amount of depreciation we need to record as an adjusting journal entry in our General Journal. This is recorded by increasing our Depreciation Expense Account (Debit) by $3100 and decreasing our Asset Account Truck (Credit) by $3100. We recorded the entire year's depreciation expense in the month of December.
What should we actually have done during our year ? If we were on our toes, we would have made an adjusting entry in each month increasing our Expense Account Depreciation Expense (Debit) for $258.33 and decreasing our Asset Account Truck (Credit) for $258.33. Where did we get the amount of $258.33 ? Simple math. We divided our yearly depreciation amount of $3,100 which is the amount for the entire year by the number of periods (months) in a year to arrive at the amount per month.
We reviewed our receiving reports and found that we had incurred a maintenance expense in December for $500 that had not yet been billed by WeFixIt Company.
Type of Adjusting Entry: Accruals- Unrecorded
Here's an example of where those accrual and matching accounting rules come in to play. As you recall, the accrual basis records income in the period earned and all expenses in the period incurred (benefited). The matching concept is recording the revenues earned during a period and matching (offsetting) the revenues with the expenses incurred in generating this revenue.
At the end of each period we need to perform a review to determine if any financial transactions have occurred that we have not entered in our Special Journals. Our example is one instance of a transaction that has occurred where we have not received all the formal documents that represent the transaction. In this case, our supplier for maintenance services has not yet sent us a formal invoice. Can't we wait until we get the invoice to record this transaction ? You probably could, but if you want as accurate as possible information recorded you need to make an adjusting journal entry to record this transaction in the period that was benefited. If I don't have an invoice how do I know the cost ? In these type of instances a good estimate is better than not recording the transaction at all. Other source documents such as a purchase order may even have the necessary cost information. You could also obtain the necessary information by calling your supplier.
The adjusting entry needed to record this transaction is to increase our Expense Account Maintenance & Repairs (Debit) by $500 and increase our Liability Account Other Accruals (Credit) by $500.
During a review of our supplier's invoices, we found an invoice for $250 that was charged to Advertising Expense that should have been charged to Professional Fees.
Type of Adjusting Entry: Correcting Entries- Used
to fix mistakes
This type of mistake is only found by analyzing your accounts in order to see that all expenses and/or revenues were recorded in the proper accounts. One of the main purposes of maintaining our books is to provide us with accurate management information so we can take corrective actions when we need to. In this example, our professional fees would have been understated $250 and our advertising expenses would have been overstated $250. Since they offset each other, no big deal right ? Yes and no. Although our total debits and credits are in balance, I was taught as a kid that a job worth doing is worth doing right. We all know mistakes do happen (hopefully not often). Adjusting journal entries provide us a way of fixing them.
The adjusting entry needed to fix our error is to increase our Expense Account Professional Fees (Debit) by $250 and decrease our Expense Advertising Account (Credit) by $250.
Adjusting Entry (9)
On December 31, xxxx Smart Computerguy decided that he needed some additional help and hired two employees to begin working the following year.
Type of Adjusting Entry: I tried to trick you. There is no adjusting entry needed for recording the decision to hire two additional employees in the following year. If you recall, only financial transactions are recorded in our formal bookkeeping records.
Year End Worksheet- Adjusting Entries
Let's discuss the Layout and what information is included in this worksheet.
In my worksheet, I also organized it into different sections for the Balance Sheet Accounts and Revenue & Expense Accounts (Income Statement). I did this so that all the information we need to prepare our Income Statement is grouped together and all the information needed to prepare our Balance Sheet is also grouped together.
Note:Refer to our Actual Worksheet Below that contains the listing of our accounts and balances to see how Totals and Groupings are used. Groups used in the Worksheet include Total Balance Sheet Accounts, Total Revenue/Expense Accounts, and Total All Accounts.
Remember, your Worksheet is just an "informal" accounting record that aids you in preparing your adjusting and closing entries. You also need to know that other bookkeeping text books and tutorials may present a slightly different layout for their Worksheets. One difference that you might run across is that they include Columns in their Worksheet for Income Statement Accounts and Balance Sheet Accounts and use only one Worksheet for preparing their Adjusting and Closing entries. Instead of these columns I used Sections in my Worksheet. I also have used two Worksheets in this tutorial. One Worksheet for Adjusting Entries and another Worksheet for Closing Entries.
Below, I have provided a sample of another type of Worksheet Structure that includes Adjusting and Closing Entries in one worksheet that you may run across. This lesson will use two Worksheets one for Adjusting Entries and one for Closing Entries because I think it makes the concepts a little easier to understand for the beginning bookkeeping student.
Clicking on the Numbered Link (1), (2), etc. takes you to the explanation of why the entry was needed. To Return Click on the Underlined Worksheet Link.
Note:Not all entries in our Worksheet have a link. Only the first entry for each transaction has a link to the explanation of why the entry was needed; however, you can easily determine all the accounts affected in the worksheet by matching the reference number of the transaction to all the accounts affected. All the accounts affected will have the same reference number.
Let's use Entry Number (1) as an example.
Below is our year end work sheet to help us adjust our books and prepare our adjusting entries and income statement. Do you have any idea where the figures in the Trial Balance Columns come from ? I hope you said the General Ledger.
Our Year End Worksheet #1 -Adjusting Entries
What are all those Accounts Highlighted in Yellow ? I was hoping you'd ask. That's just my way of emphasizing the Temporary Accounts. After we post our Closing Entries which we'll discuss a little later, all these accounts will have a zero balance.
Let's Prepare Our Income Statement from our Adjusted
Year End Worksheet- Closing Entries
Let's look at our definition of closing entries. Closing Entries-Entries made at the end of a period (usually year) to reduce the "temporary" account balances (revenue, expenses, and drawing accounts) to zero and transfer the summarized balances to the capital account All our Income Statement Accounts are going to be set to zero and the net balance (which is actually the profit/loss) transferred to the Capital Account in the Balance Sheet Accounts.
A quick refresher about our revenue, expenses, and draw accounts.
Let's discuss the Layout and what information is included in this worksheet.
From looking at the Worksheet, it should be readily apparent that the only Accounts affected are the Owner's Capital, Owner's Drawing Account, the Income and Expense Accounts and a New Account called Income Summary.
Clicking on an underlined alphabetic link takes you to the formal entry made in the General Journal. To return click on the same underlined alphabetic link.
Our Year End Worksheet #2 -Closing Entries
Steps In Closing The Books
Let's take a look at and discuss some of our closing entries in our worksheet.
What are all those Accounts Highlighted in Yellow in our Worksheet ? I asked this question earlier. Do you recall the answer ? They're our Temporary Accounts. The yellow highlighting is just my way of emphasizing the Temporary Accounts. After we post our Closing Entries, all these accounts will have a zero balance. Look in our After Closing Trial Balance Columns in our Worksheet and see that all our Temporary Accounts have a zero balance after we post our closing entries.
Entry (a) is our closing entry that transfers (closes ) the balance in the Drawing Account to the Capital Account. Since the current balance in our Drawing Account contained in our Adjusted Trial Balance Column is a $24,000 debit balance, the Drawing Account is credited and the Capital Account is debited. The result of this entry is removing the $24,000 debit balance from the Drawing Account and placing the $24,000 amount of the debit balance in our Capital Account. All we're actually doing is making an entry in the account that we want to close for the opposite of the debit/credit balance contained in the account that we want to close. If our closing account initially has a credit balance, we debit the account for the amount of the balance in the account and if our closing account initially contains a debit balance we credit the account we desire to close for the amount of the balance in the account. In this example, we removed the debit balance from our Drawing Account and placed it in our Capital Account. The balance in the account that is closed becomes zero as a result of the entry and is made ready for the start of the next period (normally year).
Let's use T-Accounts to illustrate.
By golly all we did was transfer the 24000 debit balance in the Owner's Drawing Account to the Owner's Capital Account. Did you notice that after the closing entry (transfer) the current balance of the Owner's Drawing Account is now zero ? Our debit balance in our Drawing Account didn't disappear it was just moved to another account. Since we credited the Owner's Drawing Account, due to the double entry accounting rule, we have to also have an offsetting debit entry to another account which in this case was our Owner's Capital Account.
To close and transfer our Revenue and Expense Account Ending Balances we use a Special General Ledger Account named Income Summary. We could close out our income and expense accounts for the period by transferring the account balances directly to our Capital Account (Owner's Equity). Instead, we use this Special Account as an "informal income statement" and only transfer one summary amount to our Capital Account. The difference between the debit and credit balance in our Income Summary Account is actually profit if the credit balance accounts (sales/revenue) are greater than the debit balance accounts and a loss if the debit balance accounts (expenses) are greater than the credit balance accounts.
Let's review some of our Revenue and Expense Account Closing Entries and the transfer of their account balances to our Income Summary Account. We'll use one Revenue Account and one Expense Account to illustrate how the Revenue and Expense Accounts are closed to the Income Summary Account. The same logic applies to all the other revenue and expense accounts.
Entry (b) Consulting Services-Revenue
Since our Income Summary Account used for closing our books is a Special "Equity" Account a decrease to the account is a debit and an increase to the account is a credit.
Using our T-Accounts again the entries are:
By golly all we did again was transfer the 50000 credit balance in the Consulting Fees Revenue Account to our special Income Summary Account. Did you notice that after the closing entry (transfer) the current balance of the Consulting Services Account is now zero ? Our credit balance in our Consulting Services Account didn't disappear it was just moved to another account. Since we debited the Consulting Services Account, due to the double entry accounting rule, we have to also have an offsetting credit entry to another account which in this case was our Income Summary Account.
Entry (d) Cost of Goods Sold-Expense
Using our helpful T-Accounts the entries are:
Shucks, all we did was transfer our debit balance of 72500 in our Expense Account Cost of Goods Sold to our Special Income Summary Account. No surprise here, the current balance of the Cost Of Goods Sold Account is now zero. Our debit balance in our Cost Of Goods Sold Account didn't disappear it was just moved to another account. Since we credited the Cost Of Goods Sold Account, due to the double entry accounting rule, we have to also have an offsetting debit entry to another account which in this case was our Income Summary Account.
The same logic and procedure that we illustrated for Entry (b) and Entry (d) is used for closing out all our Expense and Revenue Accounts to our Special Income Summary Account. Refer to our Worksheet # 2 -Closing Entries above to review all the Revenue and Expense Closing Entries.
After closing all our Revenue and Expense Account Balances to our Income Summary Account, we are now ready to close (transfer) the balance of our Income Summary Account to our Capital Account.
Look at our Subtotal in our Worksheet on our line Balance Of Income Summary Account After Closing Revenue and Expense Accounts And Prior To Transferring Profit/Loss for the debit and credit balances in our Income Summary Account. The total debits are $107,840 and the total credits are $150,000 resulting in a credit balance in our Income Summary Account of $42,160. Does this amount look familiar ? By golly, that's the amount of our profit for our year. If the Income Summary Account has a debit balance, the balance represents a Loss for the period. A credit balance represents a Profit for the period. It's no coincident that this is the amount that is closed (transferred) to our Capital Account with our entry (p) after all our Revenue and Expenses Accounts have been closed to our Income Summary Account.
Let's use our friendly T-Accounts one more time to illustrate our entries:
Our Income Summary Account has a Credit Balance of 42,160 after all our Expense and Revenue Accounts have been closed. This is shown above on the line titled Balance Prior To Closing Entry.
Entry (p) debits the Income Summary Account for $42,160 since it has a credit balance of this amount prior to closing and credits our Capital Account for $42,160. All we did is transfer our credit balance in our Temporary Income Summary Account to our Owner's Capital Account. Guess what the after closing ending balance of our Income Summary Account is ? I hope you said zero.
The Capital Account Balance after the Owner's Drawing Account and Income Summary Account have been closed is a credit balance of 40260 calculated by taking our beginning balance of 22100 and adding our profit of 42160 and subtracting our owner draws of 24000.
If our Income Summary Account had contained a debit balance prior to closing, we would have credited our Income Summary Account and debited our Capital Account. What would this debit balance represent ? A Loss unfortunately.
Look at our Worksheet. The Income Summary's Beginning Account Adjusted Trial Balance Amount is zero as is it's After Closing Trial Balance Amount. This illustrates the temporary nature of our Income Summary Account. The account is only used as an aid for closing our books.
Well that takes care of our Closing Entries. In the real world, your outside accountant often helps in preparing the Adjusting and Closing Entries.
Prepare Balance Sheet & Capital Statement
This layout is called the account form. In this form the major categories are presented side by side.
Another layout sometimes used is called the report form. In this form the major categories are stacked on top of each other. An example of the report form follows.
Prepare Capital Statement
All this statement does is show what caused the change in the Owner's Capital Account for the year. All the information needed to prepare this statement is contained in the Owner's Capital Account in our Year End Worksheet.
Click On the Underlined Amount (link) to see the amounts in our Year End Worksheet To Return Click on the Underlined Ending Capital Balance of 40260.
Hang tight, we've almost completed closing our books. Just a few more tasks. We've been using Worksheets as an aid for closing our books and recording our adjusting and closing entries in these worksheets. It's time to use this information to prepare and record these entries in our formal General Journal and post our General Journal entries to our formal General Ledger and any Subsidiary Ledgers.
Prepare Formal General Journal
Our General Journal
The Underlined Numeric Reference Numbers 1, 2, 3, etc. are links to the description and explanation for the Adjusting Entry. To Return to our General Journal Click on the Underlined Formal Journal link.
The Underlined Alphabetic Reference Numbers a, b, c, etc. are links to the Closing Entries Worksheet. To Return to Our General Journal Click on the same Underlined Alphabetic Link.
Of course our Posting Reference Column in our General Journal tells us know that we posted the entry to our General Ledger. What about Entry 2 that has two X's in the posting column for Accounts Receivable ? The first X tells us that we posted the entry to the Accounts Receivable Control Account in the General Ledger. The second X tells us that we also posted the entry to our Customer's Account in the Accounts Receivable Subsidiary Ledger.
I'm not a lazy accountant, but do like to save time whenever possible. Instead of debiting or crediting our Income Summary Account for the balance of each expense and revenue account, we could have used just one total amount for the debit or credit amount posted to our Income Summary Account. How do we determine what this amount should be ? Simple. If our credits to our expense accounts exceed the debits to our revenue accounts, we need a balancing debit amount for our Income Summary Account. If our debits to our revenue accounts exceed our credits to our expense account, we need a balancing credit amount for our Income Summary Account.
Do you have any idea what this figure represents ? Come on now, it's our profit or loss amount.
What's the official name for this type of Journal Entry ? I'll give you a hint. What's the bold topic heading for this section ? If you recall, a compound entry is just an entry that contains more than one debit and one credit.
Below are our Closing Entries using a compound entry for closing the revenue and expense accounts. The first entry closes our revenue and expense accounts. The second closes our Income Summary Account and transfers the balance to our Capital Account. The last closes our Owner's Drawing Account and transfers the balance to our Capital Account.
Close Revenue and Expense Accounts
Since in this example our debits to our revenue accounts are greater than our credits to our expense accounts we need a balancing credit amount to our Income Summary Account.
Our Calculation is:
Close Income Summary Account
Close Owner's Drawing Account
Are we done yet ? You sound like the little kid in the car wanting to know if we're there yet. Almost. Our last step in order to be sure that after posting our Formal General Journal Entries that our General Ledger is in balance is to prepare a final After Closing Trial Balance.
Sure enough our debit balances equal our credit balances. And finally, we should total all our Subsidiary Ledgers to make sure that the detail balances of these records agree with the totals in General Ledger Control Accounts (Accounts Receivable, Accounts Payable, etc.).
Summary of What We Know
I don't know if you realize it our not, but we've covered quite a bit in our first three lessons of this tutorial.