AC 210 Lecture Notes - Lecture 17: Capital Account, Retained Earnings, Income Statement
5 Jun 2018
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Closing Entries
To update the balance in the owner's capital account, accountants close revenue,
expense, and drawing accounts at the end of each fiscal year or, occasionally, at the
end of each accounting period. For this reason, these types of accounts are
called temporary or nominal accounts. Assets, liabilities, and the owner's capital
account, in contrast, are called permanent or real accounts because their ending
balance in one accounting period is always the starting balance in the subsequent
accounting period. When an accountant closes an account, the account balance returns
to zero. Starting with zero balances in the temporary accounts each year makes it
easier to track revenues, expenses, and withdrawals and to compare them from one
year to the next. There are four closing entries, which transfer all temporary account
balances to the owner's capital account.
1. Close the income statement accounts with credit balances (normally revenue
accounts) to a special temporary account named income summary.
2. Close the income statement accounts with debit balances (normally expense
accounts) to the income summary account. After all revenue and expense
accounts are closed, the income summary account's balance equals the
company's net income or loss for the period.
3. Close income summary to the owner's capital account or, in corporations, to the
retained earnings account. The purpose of the income summary account is
simply to keep the permanent owner's capital or retained earnings account
uncluttered.
4. Close the owner's drawing account to the owner's capital account. In
corporations, this entry closes any dividend accounts to the retained earnings
account. For purposes of illustration, closing entries for the Greener Landscape
Group follow.
Closing entry 1: The lawn cutting revenue account is Mr. Green's only income
statement account with a credit balance. Debit this account for an amount equal to the
account's balance, and credit income summary for the same amount.
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Closing entry 2: Mr. Green has eight income statement accounts with debit balances;
they are all expense accounts. Close these accounts by debiting income summary for
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an amount equal to the combined debit balances of all eight expense accounts and by
crediting each expense account for an amount equal to its own debit balance.
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Document Summary
To update the balance in the owner"s capital account, accountants close revenue, expense, and drawing accounts at the end of each fiscal year or, occasionally, at the end of each accounting period. For this reason, these types of accounts are called temporary or nominal accounts. Assets, liabilities, and the owner"s capital account, in contrast, are called permanent or real accounts because their ending balance in one accounting period is always the starting balance in the subsequent accounting period. When an accountant closes an account, the account balance returns to zero. Starting with zero balances in the temporary accounts each year makes it easier to track revenues, expenses, and withdrawals and to compare them from one year to the next. The purpose of the income summary account is simply to keep the permanent owner"s capital or retained earnings account uncluttered: close the owner"s drawing account to the owner"s capital account.
