ACCG100 Lecture Notes - Lecture 6: Sole Proprietorship, General Ledger, Retained Earnings
Closing Entries
Many accounts, such as the assets, liabilities and equity accounts (capital, retained earnings), are permanent and
carried forward to future accounting periods. However, many other accounts used within an accounting period are
temporary and cannot be carried forward to future accounting periods as it would be misleading. These temporary
accounts include the revenue accounts, the expense accounts, and the drawings/dividends account.
Hence, at the end of each accounting period, these temporary aouts ust e losed so that they can begin the
next accounting period with a zero balance, ready to accumulate data about revenues, expenses and dividends in
the next accounting period separately from previous periods. This is done using closing entries, which effectively
transfer the temporary account balances to the permanent equity account at the end of the reporting period.
Closing entries thus formally recognise the transfer of profit (or loss) and dividends to capital / retained earnings.
Closing entries are recorded in the general journal and then posted to the general ledger. The process is as follows:
1. A speial teporary aout, Profit or Loss Suary aout, is reated to facilitate the closing process.
Otherwise, each statement of profit or loss account would be closed directly to retained earnings, resulting
in excessive detail in the retained earnings account.
2. Income accounts are closed: The funds in the revenue accounts have a natural credit balance. To close these,
we debit the expense account, and credit the P&L summary.
3. Expense Accounts are closed: the funds in the expense accounts have a natural debit balance. To close
these, we debit the P&L summary, and credit the expense account.
4. Close the P&L Summary to the permanent capital account: This is the capital account for a sole trader, and
the retained earnings account for a company. You increase (credit) the account if there is a profit, and
decrease (debit) the account if there is a loss.
5. The drawings/ dividends account is closed to the capital/retained earnings account: Drawings / dividends
have a natural debit balance. To close this, we debit the capital account and credit the drawings / dividends
account.
*Note: If the P&L Summary has a credit balance, then income was greater than expenditure and there was a net
profit. If it has a debit balance, then expenditure was greater than income and these was a net loss.
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
Many accounts, such as the assets, liabilities and equity accounts (capital, retained earnings), are permanent and carried forward to future accounting periods. However, many other accounts used within an accounting period are temporary and cannot be carried forward to future accounting periods as it would be misleading. These temporary accounts include the revenue accounts, the expense accounts, and the drawings/dividends account. This is done using closing entries, which effectively transfer the temporary account balances to the permanent equity account at the end of the reporting period. Closing entries thus formally recognise the transfer of profit (or loss) and dividends to capital / retained earnings. Closing entries are recorded in the general journal and then posted to the general ledger. The process is as follows: a spe(cid:272)ial te(cid:373)porary a(cid:272)(cid:272)ou(cid:374)t, (cid:858)profit or loss su(cid:373)(cid:373)ary(cid:859) a(cid:272)(cid:272)ou(cid:374)t, is (cid:272)reated to facilitate the closing process.