Closing Entries
Closing entries are the tool to close the temporary accounts and are passed to transfer the balances of the temporary accounts into the permanent accounts. These closing entries are made on the basis of accounts in the adjusted trial balance.
Closing entries are passed for all items of income and expenses so that their account balance could be made zero as these are temporary accounts. In short, we can say all income statement account items are temporary accounts and need to be closed by passing the closing entries. Closing entries are also called Closing Journal Entries.
How to pass closing entries
- The process of passing closing entries is not difficult as it seems. Follow the steps below to close the temporary accounts:
- As income accounts such as sales and gain on sale are found on the credit side of the trial balance. In order to make them zero, we have to debit it and shift the balance to income summary account by debiting it.
- As expenses accounts such as Electricity expenses and Depreciation expenses are found on the debit side of the trial balance. In order to make them zero, we have to credit it and shift the balances to income summary account by crediting it.
- Now, we need to close the income summary account as well by debiting income summary account and crediting retained earning account, if the company is making profit. However, If the company is incurring losses, then entry will be reverse by debiting retained earning account and crediting income summary account.
Example
XYZ Plc has sales revenue of $50,000. The expenses include Electricity $12,000, water $4,000 etc. The closing entries will be passed like below:
|
|
Debit |
Credit |
||
|
Sales Revenue |
|
50,000 |
|
|
|
Income Summary |
|
|
50,000 |
|
|
|
|
|
||
|
Income Summary |
|
16,000 |
|
|
|
Water Expenses |
|
|
12,000 |
|
|
Electricity Expenses |
|
|
4,000 |
Now, we can see the difference between sales revenue and total expenses is 36,000, which is found in income summary account on the credit side. We need to close the income summary account as well because it is also a temporary account. We transfer this balance of income summary account into retained earning account by passing the following entry:
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Debit |
Credit |
|||
|
Income Summary |
|
36,000 |
|
|
|
Retained Earning |
|
|
36,000 |
There are two options available for an accountant. Either he or she can transfer all items of income statement into retained earnings or to temporary income and summary account. Later, the income summary account is nullified with entry to the retained earning account. It is the choice of the accountant with which process he or she is comfortable. Now-a-days, modern accounting software do this task automatically, so there is no need to close the accounts manually. So, in an automated accounting or ERP systems, the burden over the accountant has reduced due to these automatic work.
Example
XYZ has following data available for the income statement as follows:
Sales revenue $1,000,000
Electricity expense $1,000
Salary expense $2,000
Rent expense $3,000
Interest expense $1,000
Depreciation expense $1,000
Cost of sales is 60 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} of the sales revenue.
Solution
First, we need to calculate cost of sales by multi-plying 60 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} to sale figure. So,
Cost of sales = 60 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} x 1,000,000 = 600,000
In order to close all these, accountant can pass on the following entry:
Income summary account 607,000 (Debit)
Cost of sales 600,000 (Credit)
Electricity expense 1,000 (Credit)
Salary expense 2,000 (Credit)
Rent expense 3,000 (Credit)
Interest expense 1,000 (Credit)
And in order to close the revenue account, it should be debited against retained earning account as follows.
Sales revenue 1,000,000 (Debit)
Income summary account 1,000,000 (Credit)
It should be kept in mind that dividend are not closed via income summary accounts. The reason behind this logic is that dividend is not an income statement or profit & loss account. So, it is adjusted directly with retained earning account.
Question
Tohya is involved in the digital camera production and has been r unning its business since last 11 months. Following are the adjusted balances of Tohya on December 31, 2015.
|
Debit balances |
Credit Balances |
||
|
Cash |
70,000 |
Creditors |
40,000 |
|
Inventory |
40,000 |
Unearned rent income |
30,000 |
|
Other assets |
120,000 |
Share capital |
140,000 |
|
Sales return |
30,000 |
Sales revenue |
400,000 |
|
Discount allowed |
10,000 |
Purchase return |
32,000 |
|
Purchases |
300,000 |
Discount received |
8,000 |
|
Carriage in |
20,000 |
Commission fees |
10,000 |
|
Payroll expenses |
50,000 |
||
|
Insurance expenses |
20,000 |
||
|
660,000 |
660,000 |
||
Inventory as on December 31, 2015 was physically counted and valued at 60,000.
Required:
Prepare closing entries in the books of accounts.
Tohya
Closing Entries
|
Date |
Particulars |
Debit |
Credit |
|
Expense & Revenue Summary Inventory Purchase Carriage in Sales return Sales discount Payroll expenses Insurance expense (to close all debit balances of income statement.) |
470,000 |
40,000 300,000 20,000 30,000 10,000 50,000 20,000 |
|
|
Sales Closing inventory Purchase return Purchase discount Commission income Expense & Revenue Summary (to close out all credit balances of income statement.) |
400,000 60,000 32,000 8,000 10,000 |
510,000 |
|
|
Expense & Re venue Summary Capital (Net income shifted to capital account.) |
40,000 |
40,000 |
Michael Traders is the well-known business name in the buying and selling of vegetable oils in Western part of Europe. Over the years, it has evolved as a leading trader in the industry. This is all due to the untidy efforts of its senior management who always worked hard for the betterment of the company.
The following is the trial balance of Michael Traders on 30 June, 2015.
|
Accounts |
Debit |
Credit |
|
Cash |
20,000 |
|
|
Bank |
30,000 |
|
|
Furniture & fixture |
34,000 |
|
|
Machinery |
50,000 |
|
|
Office equipment |
10,000 |
|
|
Cost of goods sold |
150,000 |
|
|
Sales return |
30,000 |
|
|
Payroll expense |
36,000 |
|
|
Prepaid adverting |
32,000 |
|
|
Inventory |
46,000 |
|
|
Goodwill |
24,000 |
|
|
Office supplies |
8,000 |
|
|
Accounts receivable |
120,000 |
|
|
Accounts payable |
20,000 |
|
|
Loan from bank |
120,000 |
|
|
Unearned rent income |
10,000 |
|
|
Payroll payable |
2,000 |
|
|
Capital |
200,000 |
|
|
Sales revenue |
208,000 |
|
|
Advance from customers |
30,000 |
Payroll expense for the year $ 30,000.
Interest payable on outstanding bank loan at 10 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} for 03 months.
Office supplies still unused $ 1,000.
Prepaid advertising $ 4,000.
Required
Closing Entries.
Solution
Michael Traders
Closing Entries
|
No. |
Particulars |
Debit |
Credit |
|
Expense & revenue summary Cost of goods Sold Sales return Payroll expense Advertising expense Office supplies expense Interest expense (Closing all debit balances of Profit & Loss account.) |
221,000 |
150,000 3,000 30,000 28,000 7,000 3,000 |
|
|
Sales Expense & revenue summary (Closing credit sales of profit & loss account.) |
208,000 |
208,000 |
|
|
Capital Expense & Revenue Summary (Net loss from the business carried to capital account). |
13,000 |
13,000 |