Chapter Three The Double-Entry Accounting System McGraw-Hill/Irwin Copyright © 2013 by The...

Chapter Three

The Double-Entry Accounting

System

McGraw-Hill/IrwinMcGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

4- 2

THE MECHANICS OF DEBITS AND CREDITS

Debit Credit

Assets

Expenses

Dividends

Revenue

Liability

Equity

4- 3

DOUBLE ENTRY ACCOUNTINGAssets = Liabilities + Common Stock + Retained

Earnings

How do these accounts increase? Debits or Credits?

Debit = Credit Credit Credit+ +

4- 4

THE ACCOUNTING CYCLE...

Transactions occur in the normal course of business. We record them in our records with a JOURNAL ENTRY (called “Journalizing”).

Journal entries are posted to the GENERAL LEDGER (called “Posting”).

ADJUSTING ENTRIES are made (journalized) and posted to the LEDGER.

Transactions Financial Statements

The Process

4- 5

ACCOUNTING CYCLE CONTINUED...

A trial balance may be prepared. It shows the balance (amount and whether debit or credit) of each account. A trial balance is NOT the same as a “Balance Sheet”, which is a formal financial statement.

Financial statements are written. Closing journal entries are made

(journalized) and posted to the ledger (and another trial balance, called the “after-closing” or “post-closing” trial balance may be prepared).

4- 6

DOUBLE-ENTRY ACCOUNTING

Each account can be increased or decreased.

Debit means “left side” Credit means “right side” Assets are increased with debits and

decreased with credits Liabilities and permanent Stockholders’

Equity are increased with credits and decreased with debits

In each journal entry, i.e. recording of a transaction, the DEBITS = CREDITS.

(No exceptions!)

4- 7

T-ACCOUNTS

Increase

ASSETS • In a transaction that

increases an asset, put that amount on the left side of the asset account.

4- 8

T-ACCOUNTS

Increase

ASSETS

Decrease • In a transaction that

increases an asset, put that amount on the left side of the asset account.

• In a transaction that decreases an asset, put that amount on the right side of the asset account.

4- 9

T-ACCOUNTSCalculate the balance of any account, at any time by:1. drawing a line across the T-account under the last

posted entry.

CASH200 100500 50300

Bal. 850

1000 total on debit side

150 total on credit side

1000 – 150 = 850

2. Adding the amounts on the left side and adding the amounts on the right side of the account.3. Subtract the two totals and put the difference on the side with the larger total.

4- 10

GENERAL LEDGER

The “T” account is a shorthand used byaccountants to analyze transactions. Itis not part of the bookkeeping system.

GENERAL LEDGERAccount: Acct. No. ## Balance

Date ItemPost. Ref. Debit Credit DR (CR)

4- 11

T-ACCOUNTS: ASSETS

CASH

debitsincreaseassets

e.g., when wereceive cash,we debit the CASH account

DEBITSon theleft!!

4- 12

T-ACCOUNTS: ASSETS

CASH

debitsincreaseassets

creditsdecreaseassets

e.g., when wereceive cash,we debit the CASH account

Creditson theright!!

e.g., when we disburse cash,we credit theCASH account

4- 13

T-ACCOUNTS: LIABILITIES AND EQUITY

Accounts Payable

credits increaseliabilities


Debits on theleft!

4- 14


Accounts Payable

credits Increaseliabilities


e.g., when werecord an amount we owe someone

Debits on theleft!

4- 15


Accounts Payable

debits decreaseliabilities




Debits on theleft!

4- 16


Accounts Payable

debits decreaseliabilities


e.g., when wepay off some of our accounts payable



Debits on theleft!

4- 17

T-ACCOUNTS

Permanent Equity accts work like liability accounts do:

LIABILITIES

creditsincreaseliabilities

debitsdecreaseliabilities

Permanent Equity Accts.are

debitsdecreaseCm. Stk. &Ret. Earn.

creditsincreaseCm. Stk. &Ret. Earn.

Com. Stk. & Ret.Earn.

Additions to theseaccounts are put on the right.

Deductions from these accounts are put on the left.

4- 18

HOW DO JOURNAL ENTRIES RELATE TO T-ACCOUNTS?

Journal entries are recorded chronologically as the transactions occur (before “posting” to General Ledger):

e.g., On Jan. 6 services are performed for our customers for which we collect $100 cash:

Date Account Title Debit Credit

Jan. 6 Cash 100The asset “CASH” is increasing. Increases in assets are recorded by DEBITING the asset account.

4- 19

HOW DO JOURNAL ENTRIES RELATE TO T-ACCOUNTS?

Journal entries are recorded chronologically as the transactions occur:

e.g., On Jan. 6 services are performed for $100 cash:

Date Account Title Debit Credit Jan. 6 Cash 100

Service Revenue 100 An explanation goes here.

Journal entries are written in a journal and then posted to the general ledger accounts (our t-accounts).

Increases in revenue accounts are recorded with CREDITS.

4- 20

General Journal Date Account Title

Debit Credit Jan. 6 Cash 100

Service Revenue 100

Services rendered for cash Post from General Journal to the General Ledger

100 100

Cash Service Revenue

4- 21

NORMAL BALANCES

The normal balance of any account is the side where you record the INCREASES.

For example, ASSETS are increased by DEBITING them. So, the normal balance of any asset account is a DEBIT balance.

4- 23

JOURNAL ENTRY FORM

When journalizing, the debit portion of the entry is recorded first. The account title is written starting at the left margin.

The credit portion is recorded next. The name of the account to be credited is written on the line below the debit and the title is indented.

A “line of explanation” may be written next.

Skip-a-line between transactions.

4- 24

BALANCE SHEET (and Accounting Equation) INCOME STATEMENT CASHFLOW ASSETS = LIABILITIES + STK. EQUITY STATEMENT

Acc't. PrePaid Salary Unearn Com. Ret. Net OA,IA,FA

Cash + Rec. + Rent + Supplies = Pay. + Rev. + Stk. + Earn. Rev. - Exp. = Inc. $ amt

BB 5,000 4,000 = 7,000 2,000 5,000 bal.

Beginning Balances (ending balances from last year)

GENERAL JOURNALDate Account Titles Debit Credit

GENERAL LEDGER ("T" - Accounts) Assets = Liabilities + Equity

Cash Accounts Receiv. Unearned Serv.Rev. Common Stock Retained Earningsbb 5000 bb 4000 7000 bb 2000 bb

Prepaid Rent Salaries Payable Service Revenue Supplies Expense

Salaries Expense Rent Expense

Supplies

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1 1,000 1,000 1,000 FA

1. On Jan. 2, issued Common Stock for $1,000 cash.


Jan. 2 Cash 1000Common Stock 1000

Issued Stock for cash


Cash Accounts Receiv. Unearned Serv.Rev. Common Stock Retained Earningsbb 5000 bb 4000 7000 bb 2000 bb1/2 1000 1000 1/2

Prepaid Rent Office Equipment Salaries Payable Service Revenue Depreciation Exp.

Accumulated Deprec. Salaries Expense Rent Expense

The asset CASH is increasing. Increases in assets are recorded with DEBITS.

The permanent Stockholders’ Equity account, COMMON STOCK, is increasing. Increases in permanent Equity accounts are recorded with CREDITS.

Now let’s POST from the JOURNAL to the LEDGER.

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1 1,000 1,000 1,000 FA

1. On Jan. 2, issued Common Stock for $1,000 cash.


Jan. 2 Cash 1000Common Stock 1000

Issued Stock for cash


Cash Accounts Receiv. Unearned Serv.Rev. Common Stock Retained Earningsbb 5000 bb 4000 7000 bb 2000 bb1/2 1000 1000 1/2

Prepaid Rent Salaries Payable Service Revenue Supplies Expense


Supplies

4- 27




2 7,000 = 7,000 7,000 7,000

2. On Feb. 1, performed customer services for $7,000 on account.


Feb. 1 Accounts Receivable 7000Service Revenue 7000

Performed customer services on credit.


Cash Accounts Receiv. Unearned Serv.Rev. Common Stock Retained Earningsbb 5000 bb 4000 7000 bb 2000 bb1/2 1000 2/17000 1000 1/2

Prepaid Rent Office Equipment Salaries Payable Service Revenue Depreciation Exp.7000 2/1


The asset ACCOUNTS RECEIVABLE is increasing. Increases in assets are recorded with DEBITS.

The revenue account, SERVICE REVENUE, is increasing. Increases in revenue accounts are recorded with CREDITS.


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2 7,000 = 7,000 7,000 7,000

2. On Feb. 1, performed customer services for $7,000 on account.


Feb. 1 Accounts Receivable 7000Service Revenue 7000

Performed customer services on credit.


Cash Accounts Receiv. Unearned Serv.Rev. Common Stock Retained Earningsbb 5000 bb 4000 7000 bb 2000 bb1/2 1000 2/17000 1000 1/2

Prepaid Rent Salaries Payable Service Revenue Supplies Expense7000 2/1


Supplies

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3 8,000 = 8,000 8,000 OA

3. On Mar. 7, collected $8,000 cash from customers for services to be performed in the future.


Mar. 7 Cash 8000Unearned Service Revenue 8000

Collected cash for future services.


Cash Accounts Receiv. Unearned Serv.Rev. Common Stock Retained Earningsbb 5000 bb 4000 8000 3/7 7000 bb 2000 bb1/2 1000 2/17000 1000 1/2

3/7 8000

Prepaid Rent Office Equipment Salaries Payable Service Revenue Depreciation Exp.7000 2/1



The liability account, UNEARNED SERVICE REVENUE, is increasing. Increases in liability accounts are recorded with CREDITS.


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3 8,000 = 8,000 8,000 OA

3. On Mar. 7, collected $8,000 cash from customers

for services to be performed in the future.


Mar. 7 Cash 8000Unearned Service Revenue 8000

Collected cash for future services.


Cash Accounts Receiv. Unearned Serv.Rev. Common Stock Retained Earningsbb 5000 bb 4000 8000 3/7 7000 bb 2000 bb1/2 1000 2/17000 1000 1/2

3/7 8000

Prepaid Rent Salaries Payable Service Revenue Supplies Expense7000 2/1


Supplies

4- 32




4 7,000 (7,000) = 7,000 OA

4. On April 9th, collected $7,000 of the receivables.


Apr. 9 Cash 7000Accounts Receivable 7000

Collected $7,000 cash from customers' receivables.


Cash Accounts Receiv. Unearned Serv.Rev. Common Stock Retained Earningsbb 5000 bb 4000 7000 4/9 8000 3/7 7000 bb 2000 bb1/2 1000 2/17000 1000 1/2

3/7 80004/9 7000 Prepaid Rent Office Equipment Salaries Payable Service Revenue Depreciation Exp.

7000 2/1



The asset account, ACCOUNTS RECEIVABLE, is decreasing. Decreases in asset accounts are recorded with CREDITS.


4- 33




4 7,000 (7,000) = 7,000 OA

4. On April 9th, collected $7,000 of the receivables.


Apr. 9 Cash 7000Accounts Receivable 7000

Collected $7,000 cash from customers' receivables.


Cash Accounts Receiv. Unearned Serv.Rev. Common Stock Retained Earningsbb 5000 bb 4000 7000 4/9 8000 3/7 7000 bb 2000 bb1/2 1000 2/17000 1000 1/2

3/7 80004/9 7000 Prepaid Rent Salaries Payable Service Revenue Supplies Expense

7000 2/1


Supplies

4- 34




5 (2,000) = (2,000) 2,000 (2,000) (2,000) OA

5. On May 3, paid $2,000 salaries in cash.


May 3 Salaries Expense 2000Cash 2000

Paid $2,000 salaries in cash.


Cash Accounts Receiv. Unearned Serv.Rev. Common Stock Retained Earningsbb 5000 2000 5/3 bb 4000 7000 4/9 8000 3/7 7000 bb 2000 bb1/2 1000 2/17000 1000 1/2


7000 2/1

Salaries Expense Rent Expense5/3 2000

Supplies

4- 35




6 (9,000) 9,000 = (9,000) OA

6. On July 1, purchased supplies by paying $9,000 cash.


July 1 Supplies 9000Cash 9000

Purchased supplies for $9,000 cash.


Cash Accounts Receiv. Unearned Serv.Rev. Common Stock Retained Earningsbb 5000 2000 5/3 bb 4000 7000 4/9 8000 3/7 7000 bb 2000 bb1/2 1000 9000 7/1 2/17000 1000 1/2

3/7 80004/9 7000 Prepaid Rent Office Equipment Salaries Payable Service Revenue Depreciation Exp.

7/1 9000 7000 2/1

Accumulated Deprec. Salaries Expense Rent Expense5/3 2000

The asset, Supplies, is increasing. Increases in assets are recorded with DEBITS.

The asset account, CASH, is decreasing. Decreases in asset accounts are recorded with CREDITS.


4- 36




6 (9,000) 9,000 = (9,000) OA

6. On July 1, purchased supplies by paying $9,000 cash.


July 1 Supplies 9000Cash 9000

Purchased supplies for $9,000 cash.




7/1 9000 7000 2/1


Supplies

4- 37




7 (3,000) 3,000 = (3,000) OA

7. On Nov. 1, paid $3,000 to rent office space for the next three months.


Nov. 1 Prepaid Rent 3000Cash 3000

Prepaid 3 months rent for $3,000.



3/7 8000 3000 11/1

4/9 7000 Prepaid Rent Office Equipment Salaries Payable Service Revenue Depreciation Exp.11/1 3000 7/1 9000 7000 2/1


The asset PREPAID RENT is increasing. Increases in assets are recorded with DEBITS.

The asset account, CASH, is decreasing. Decreases in asset accounts are recorded with CREDITS.


4- 38




7 (3,000) 3,000 = (3,000) OA

7. On Nov. 1, paid $3,000 to rent office space for the next three months.


Nov. 1 Prepaid Rent 3000Cash 3000

Prepaid 3 months rent for $3,000.



3/7 8000 3000 11/1

4/9 7000 Prepaid Rent Salaries Payable Service Revenue Supplies Expense11/1 3000 7/1 9000 7000 2/1


Supplies

4- 39

ADJUSTING ENTRIES... Before financial statements are

prepared, adjusting entries must be journalized and posted to make sure that all accounts are properly stated and that nothing has been omitted.

Adjustments need to be made for all: Accruals (Accrued Revenues

and Accrued Expenses) Deferrals (Deferred Revenues

and Deferred Expenses)

4- 40




3 8,000 = 8,000 8,000 OA

8 = (2,000) 2,000 2,000 2,000

8. Year-end adjustment recognizing ¼ of services required by transaction #3 have been performed.


Dec. 31 Unearned Service Revenue 2000Service Revenue 2000

Completed 1/4 of work on $8,000 contract.


Cash Accounts Receiv. Unearned Serv.Rev. Common Stock Retained Earningsbb 5000 2000 5/3 bb 4000 7000 4/9 adj 2000 8000 3/7 7000 bb 2000 bb1/2 1000 9000 7/1 2/17000 1000 1/2

3/7 8000 3000 11/1

4/9 7000 Prepaid Rent Office Equipment Salaries Payable Service Revenue Depreciation Exp.11/1 3000 7/1 9000 7000 2/1

2000 adj


The liability account, UNEARNED SERVICE REVENUE, is decreasing. Decreases in liabilities are recorded with DEBITS.

The revenue account, SERVICE REVENUE, is increasing. Increases in revenue accounts are recorded with CREDITS.


4- 41




3 8,000 = 8,000 8,000 OA

8 = (2,000) 2,000 2,000 2,000

8. Year-end adjustment recognizing ¼ of services required by transaction #3 have been performed.


Dec. 31 Unearned Service Revenue 2000Service Revenue 2000

Completed 1/4 of work on $8,000 contract.



3/7 8000 3000 11/1

4/9 7000 Prepaid Rent Salaries Payable Service Revenue Supplies Expense11/1 3000 7/1 9000 7000 2/1

2000 adj


Supplies

4- 42




9 (1,000) = (1,000) 1,000 (1,000)

9. A physical count reveals that there are $8,000 of supplies left over. Supplies of $1,000 were used.


Dec. 31 Supplies Expense 1000Supplies 1000

$1,000 of Supplies were used.



3/7 8000 3000 11/1

4/9 7000 Prepaid Rent Salaries Payable Service Revenue Depreciation Exp.11/1 3000 7/1 9000 7000 2/1 adj 1000

2000 adj

Accumulated Deprec. Salaries Expense Rent Expense1000 adj 5/3 2000

Supplies

The expense account, SUPPLIES EXPENSE, is increasing. Increases in expenses are recorded with DEBITS.

The asset account, SUPPLIES, is decreasing. Decreases in asset accounts are recorded with CREDITS.


4- 43




9 (1,000) = (1,000) 1,000 (1,000)

9. A physical count reveals that there are $8,000 of supplies left over. Supplies of $1,000 were used.


Dec. 31 Supplies Expense 1000Supplies 1000

$1,000 of Supplies were used.



3/7 8000 3000 11/1

4/9 7000 Prepaid Rent Salaries Payable Service Revenue Supplies Expense11/1 3000 7/1 9000 7000 2/1 adj 1000

1000 adj 2000 adj


Supplies

4- 44




7 (3,000) 3,000 = (3,000) OA

10 (2,000) = (2,000) 2,000 (2,000)

10. Year-end rent adjustment.$3000/3 Mo. = $1,000/mo. Nov. & Dec. expired =$2,000.


Dec. 31 Rent Expense 2000Prepaid Rent 2000

Two months (Nov. & Dec.) prepaid rent expired.



3/7 8000 3000 11/1

4/9 7000 Prepaid Rent Office Equipment Salaries Payable Service Revenue Depreciation Exp.11/1 3000 2000 adj 7/1 9000 7000 2/1 adj 1000

2000 adj

Accumulated Deprec. Salaries Expense Rent Expense1000 adj 5/3 2000 adj 2000

The expense account, RENT EXPENSE, is increasing. Increases in expenses are recorded with DEBITS.

The asset account, PREPAID RENT, is decreasing. Decreases in assets are recorded with CREDITS.


4- 45




7 (3,000) 3,000 = (3,000) OA

10 (2,000) = (2,000) 2,000 (2,000)

10. Year-end rent adjustment.$3000/3 Mo. = $1,000/mo. Nov. & Dec. expired =$2,000.


Dec. 31 Rent Expense 2000Prepaid Rent 2000

Two months (Nov. & Dec.) prepaid rent expired.



3/7 8000 3000 11/1

4/9 7000 Prepaid Rent Salaries Payable Service Revenue Supplies Expense11/1 3000 2000 adj 7/1 9000 7000 2/1 adj 1000

1000 adj 2000 adj

Salaries Expense Rent Expense5/3 2000 adj 2000

Supplies

4- 46




11 = 600 (600) 600 (600)

11. Year-end adjustment to accrue $600 salaries.


Dec. 31 Salaries Expense 600Salaries Payable 600

Accrue $600 salaries incurred, but not yet paid.



3/7 8000 3000 11/1

4/9 7000 Prepaid Rent Office Equipment Salaries Payable Service Revenue Depreciation Exp.11/1 3000 2000 adj 7/1 9000 600 adj 7000 2/1 adj 1000

2000 adj

Accumulated Deprec. Salaries Expense Rent Expense1000 adj 5/3 2000 adj 2000

adj 600

The expense account, SALARIES EXPENSE is increasing. Increases in expenses are recorded with DEBITS.

The liability account, SALARIES PAYABLE, is increasing. Increases in liability accounts are recorded with CREDITS.


4- 47




11 = 600 (600) 600 (600)

11. Year-end adjustment to accrue $600 salaries.


Dec. 31 Salaries Expense 600Salaries Payable 600

Accrue $600 salaries incurred, but not yet paid.



3/7 8000 3000 11/1

4/9 7000 Prepaid Rent Salaries Payable Service Revenue Supplies Expense11/1 3000 2000 adj 7/1 9000 600 adj 7000 2/1 adj 1000

1000 adj 2000 adj

Salaries Expense Rent Expense5/3 2000 adj 2000adj 600

Supplies

4- 48


Dec. 31 Dividends 400Cash 400

$400 dividend paid to stockholders.



3/7 8000 3000 11/14/9 7000 400 12/31 Dividends

Salaries Payable 12/31 400 600 adj

Prepaid Rent Service Revenue Supplies Expense11/1 3000 2000 adj 7/1 9000 7000 2/1 adj 1000

1000 adj 2000 adj

Salaries Expense Rent Expense5/3 2000 adj 2000adj 600

Supplies

Let’s assume one additional transaction.On Dec. 31, the Patriot Co. paid its stockholders a $400 cash dividend.The “Dividends” account is a “contra-equity” account. An increase in this account results in a decrease in the Retained Earnings portion of equity.

4- 49

Calculate ledger account ending balances (eb) after all adjustments have been posted.


Cash Accounts Receiv. Unearned Serv.Rev. Common Stock Retained Earningsbb 5000 2000 5/3 bb 4000 7000 4/9 adj 2000 8000 3/7 7000 bb 2000 bb1/2 1000 9000 7/1 2/1 7000 6000 eb 1000 1/2

3/7 8000 3000 11/1 eb 4000 8000 eb4/9 7000 400 12/31

eb 6600 Dividends12/31 400

Prepaid Rent Salaries Payable eb 40011/1 3000 2000 adj 7/1 9000 600 adj Service Revenue Supplies Expenseeb 1000 1000 adj 600 eb 7000 2/1 adj 1000

eb 8000 2000 adj eb 10009000 eb

Salaries Expense Rent Expense5/3 2000 adj 2000adj 600 eb 2000eb 2600

Supplies

This is still the beginning balance until the closing entries are made.

4- 50

TRIAL BALANCE Since debits = credits in all journal entries, at any point in time we should be able to take the balances in all of our general ledger accounts and confirm that DEBITS = CREDITS for all accounts together.

debits credits

Trial Balances are commonly prepared both before and after recording adjusting entries (and after recording “closing” entries, which will be explained later).

4- 51

ADJUSTED TRIAL BALANCE FOR PATRIOT COMPANY

Accounts in Ledger Dr. Cr.Cash 6600Accounts. Receivable 4000Prepaid Rent 1000Supplies 8000Unearned Serv. Revenue 6000 Salaries Payable 600Common Stock 8000Retained Earnings 2000Dividends 400Service Revenue 9000Supplies Expense 1000Salaries Expense 2600Rent Expense 2000 Totals 25,600 25,600

GENERAL LEDGER ("T" - Accounts) Assets

Cash Accounts Receiv.bb 5000 2000 5/3 bb 4000 7000 4/91/2 1000 9000 7/1 2/1 70003/7 8000 3000 11/1 eb 40004/9 7000 400 12/31

eb 6600

Prepaid Rent11/1 3000 2000 adj 7/1 9000eb 1000 1000 adj

eb 8000

Supplies

4- 52


Accounts in Ledger Dr. Cr.Cash 6600Accounts. Receivable 4000Prepaid Rent 1000Supplies 8000Unearned Serv. Revenue 6000 Salaries Payable 600Common Stock 8000Retained Earnings 2000Dividends 400Service Revenue 9000Supplies Expense 1000Salaries Expense 2600Rent Expense 2000 Totals 25,600 25,600

LiabilitiesUnearned Serv.Rev.

adj 2000 8000 3/7

6000 eb

Salaries Payable 600 adj

600 eb

4- 53


Accounts in Ledger Dr. Cr.Cash 6600Accounts. Receivable 4000Prepaid Rent 1000Supplies 9000Unearned Serv. Revenue 6000 Salaries Payable 600Common Stock 8000Retained Earnings, begin. 2000Dividends 400Service Revenue 9000Supplies Expense 1000Salaries Expense 2600Rent Expense 2000 Totals 25,600 25,600

Equity Common Stock Retained Earnings

7000 bb 2000 bb1000 1/2

8000 eb

Dividends12/31 400

Service Revenue Supplies Expense7000 2/1 adj 10002000 adj eb 10009000 eb


4- 54


debits credits

Accounts in Ledger Dr. Cr.Cash 6600Accounts. Receivable 4000Prepaid Rent 1000Supplies 8000Unearned Service Revenue 6000 Salaries Payable 600Common Stock 8000Retained Earnings 2000Dividends 400Service Revenue 9000Supplies Expense 1000Salaries Expense 2600Rent Expense 2000 Totals 25,600 25,600

This is the Trial Balance based on the balances of each Ledger account (T-acct) after the adjusting entries have been journalized and posted.

=

4- 55

LEDGER ACCOUNT BALANCES AFTER THE ADJUSTING ENTRIES, BUT BEFORE THE CLOSING ENTRIES, ARE THE DOLLAR AMOUNTS THAT GO ON THE FINANCIAL STATEMENTS.

4- 56

THE GOAL OF THE WHOLE PROCESS:

Financial Statements that reflect the true financial condition and transactions of the company Balance Sheet Income Statement Statement of Changes in

Stockholders’ Equity

Statement of Cash Flows

communicating

information

to users

4- 57

CLOSING ENTRIES

All temporary “nominal” accounts (income statement accounts and dividends) are closed at the end of the accounting period, after the financial statements are prepared.

Their balances are brought to ZERO, and the offsetting entry is made to the retained earnings account.

4- 58

CLOSING ENTRIES Since revenue

and expense accounts keep track of transactions for a period of time, we need them to be zero at the end of an accounting period.

To do this, we close them to retained earnings.

This effectively kicks them from the income statement to the balance sheet.

IncomeStatement(revenues and expenses)

BalanceSheet(Retained Earnings part of equity)

4- 59

JOURNAL ENTRIES TO CLOSE REVENUE AND EXPENSE ACCOUNTS: CLOSING ENTRIES

Like all entries, closing entries are Journalized and then Posted.

Revenue accounts have credit balances, so we must DEBIT them to close them (to get a zero balance).

What should we credit?

Retained Earnings

4- 60

CLOSING CONTINUED...

Because expense accounts have debit balances, to close expense accounts we credit the expense account and debit the Retained Earnings account.

We are emptying the revenue and expense accounts...

Their balances must be “zero” after closing.

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Only the temporary equity accounts below will be closed.


Cash Accounts Receiv. Unearned Serv.Rev. Common Stock Retained Earningsbb 5000 2000 5/3 bb 4000 7000 4/9 adj 2000 8000 3/7 7000 bb 2000 bb1/2 1000 9000 7/1 2/1 7000 6000 eb 1000 1/2

3/7 8000 3000 11/1 eb 4000 8000 eb4/9 7000 400 12/31

eb 6600 Dividends12/31 400

Prepaid Rent Salaries Payable eb 40011/1 3000 2000 adj 7/1 9000 600 adj Service Revenue Supplies Expenseeb 1000 1000 adj 600 eb 7000 2/1 adj 1000

eb 8000 2000 adj eb 10009000 eb


Supplies

4- 62


Closing Entries

31 Service Revenue 9000Retained Earnings 9000

to close all revenue accounts


Cash Accounts Receiv. Unearned Serv.Rev. Common Stock Retained Earningsbb 5000 2000 5/3 bb 4000 7000 4/9 adj 2000 8000 3/7 7000 bb 2000 bb1/2 1000 9000 7/1 2/1 7000 6000 eb 1000 1/2 9000 cl3/7 8000 3000 11/1 eb 4000 8000 eb4/9 7000 400 12/31

eb 6600 Salaries Payable Dividends 600 adj 12/31 400

Prepaid Rent 600 eb eb 40011/1 3000 2000 adj 7/1 9000eb 1000 1000 adj Service Revenue Supplies Expense

eb 8000 7000 2/1 adj 10002000 adj eb 1000

cl 9000 9000 eb 0

Supplies

Journalize and Post the Closing Entries

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Date Account Titles Debit Credit

31 Retained Earnings 5600Supplies Expense 1000Salaries Expense 2600Rent Expense 2000

to close all expense accounts


Cash Accounts Receiv. Unearned Serv.Rev. Common Stock Retained Earningsbb 5000 2000 5/3 bb 4000 7000 4/9 adj 2000 8000 3/7 7000 bb 2000 bb1/2 1000 9000 7/1 2/1 7000 6000 eb 1000 1/2 cl 5600 9000 cl3/7 8000 3000 11/1 eb 4000 8000 eb4/9 7000 400 12/31

eb 6600 Salaries Payable Dividends 600 adj 12/31 400

Prepaid Rent Supplies 600 eb eb 40011/1 3000 2000 adj 7/1 9000

eb 1000 1000 adj Service Revenue Supplies Expense

eb 8000 7000 2/1 adj 10002000 adj eb 1000 1000 cl

cl 9000 9000 eb 0 0

Salaries Expense Rent Expense5/3 2000 adj 2000adj 600 eb 2000 2000 cleb 2600 2600 cl 0 0

4- 64

ONE MORE ACCOUNT TO CLOSE:

Retained EarningsBeginning balance

Revenues Dividends

Ending balance

The DIVIDENDS (to stockholders) account is closed by crediting it (since it has a debit balance) and making an offsetting debit to RETAINED EARNINGS.

Expenses

Dividends

DividendsDividends

Balance before closing

4- 65


Dividends (Distributions) Retained Earnings

Bal. 400 2000 Beg. Bal.

(exp) 5600 9000 (rev.)

The DIVIDENDS (to stockholders) account is

closed with a credit (since it has a debit balance) and an offsetting debit to RETAINED EARNINGS.

4- 66



Bal. 400 2000 Beg. Bal.

(exp) 5600 9000 (rev.)

400 (to close) (div.) 400

end 0 5000 End Bal.

The DIVIDENDS (to stockholders) account is closed with a credit (since it has a debit balance) and an offsetting debit to RETAINED EARNINGS.

4- 67



Bal. 400 2000 Beg. Bal.

(exp) 5600 9000 (rev.)

400 (to close) (div.) 400

end 0

5000 End Bal.

The DIVIDENDS (to stockholders) account is closed with a credit (since it has a debit balance) and an offsetting debit to RETAINED EARNINGS.

Do NOT close the Retained Earnings account. Its $5,000 ending balance becomes the beginning balance of the next period.

4- 68

GENERAL JOURNAL

Date Account Titles Debit Credit 31 Retained Earnings 400

Dividends 400to close the Dividends account


Cash Accounts Receiv. Unearned Serv.Rev. Common Stock Retained Earningsbb 5000 2000 5/3 bb 4000 7000 4/9 adj 2000 8000 3/7 7000 bb 2000 bb1/2 1000 9000 7/1 2/1 7000 6000 eb 1000 1/2 cl 5600 9000 cl3/7 8000 3000 11/1 eb 4000 8000 eb cl 4004/9 7000 400 12/31 5000 ebeb 6600 Salaries Payable Dividends

600 adj 12/31 400 Prepaid Rent 600 eb eb 400 400 cl11/1 3000 2000 adj 7/1 9000 0eb 1000 1000 adj Service Revenue

eb 8000 7000 2/1 adj 10002000 adj eb 1000 1000 cl

cl 9000 9000 eb 0 0

Salaries Expense Rent Expense5/3 2000 adj 2000adj 600 eb 2000 2000 cleb 2600 2600 cl 0 0

Supplies

Supplies Expense

4- 69

GENERAL JOURNAL

Date Account Titles Debit Credit Closing Entries

Dec. 31 Service Revenue 9000Retained Earnings 9000

to close all revenue accounts

31 Retained Earnings 5600Supplies Expense 1000Salaries Expense 2600Rent Expense 2000

to close all expense accounts

31 Retained Earnings 400Dividends 400

to close the Dividends account

Summary of Closing Entries in the Journal

4- 70

THE POST-CLOSING TRIAL BALANCE A trial balance written

after closing the books is called a post-closing or after-closing trial balance.

What accounts will have non-zero balances on this trial balance?

THE END

Assets Liabilities Permanent Stockholders’ Equity accts. (Common Stock & Ret. Earn.)

There will be NO balances in Revenue, Expense or Dividend accounts on this Trial Balance. So, they may be omitted from this Trial Balance.

4- 71

POST-CLOSING TRIAL BALANCE FOR PATRIOT COMPANY

debits credits

Accounts in Ledger Dr. Cr.Cash 6600Accounts. Receivable 4000Prepaid Rent 1000Supplies 8000Unearned Service Revenue 6000 Salaries Payable 600Common Stock 8000Retained Earnings (end) 5000Dividends 0Service Revenue 0SuppliesExpense 0Salaries Expense 0Rent Expense 0 Totals 19,600 19,600

This is the Trial Balance based on the balances of each Ledger account (T-acct) after the closing entries have been journalized and posted.

=

Totals 19,600 19,600

Because the Revenue, Expense, and Dividend accounts have zero balances they may be left off the Post-closing Trial Balance.

4- 72

POST-CLOSING TRIAL BALANCE FOR PATRIOT COMPANY

debits credits

Accounts in Ledger Dr. Cr.Cash 6600Accounts. Receivable 4000Prepaid Rent 1000Supplies 9000Unearned Service Revenue 6000 Salaries Payable 600Common Stock 8000Retained Earnings (end) 5000

Totals 19,600 19,600

Notice that Retained Earnings account now has the ending balance in it. The effect of the income statement accounts and dividends account are now included in Retained Earnings.

=

4- 73

CHAPTER 3

The End

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Chapter Three The Double-Entry Accounting System McGraw-Hill/Irwin Copyright © 2013 by The...

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