At the end of each fiscal period, the company wants to clear out certain accounts, so that they have zero balances carrying forward› This is done after financial statements

have been prepared (there must be totals in all accounts to do this process)

The business will clear out the Nominal Accounts and leave the Real Accounts alone

WHY DO WE CLOSE OUT ACCOUNTS?WHY DO WE CLOSE OUT ACCOUNTS? Closing various accounts allows us to plainly observe the previous year's effect on our revenue, expense, and drawings accounts.

You can well imagine that if we did not close these accounts, their balances would build to outrageous amounts. › Easier to analyze the numbers if we know we

made x amount of money in 2011 and spent y.

REAL ACCOUNTS – balances that continue into the next fiscal periodex. Bank, trucks, accounts payable etc.

NOMINAL ACCOUNTS – have balances that do not continue into the next fiscal periodONLYONLY Expenses, drawing and revenue

CLOSING OUT AN ACCOUNT – means to make it have no balance. Nominal accounts are closed out at the end of the fiscal period.

INCOME SUMMARY ACCOUNT – – summarizes the revenues and expenses of the period. Represents either the net income or net loss for the fiscal period› A temporary account that aids us in the closing

entry process› This will never have a balance at the end of the

month, therefore is not necessary to classify as an asset, liability, expense or revenue account

HOW DO WE DO THIS?HOW DO WE DO THIS? At the end of each month, there is an order in which we close out accounts

1. Close out all the accounts that have credit balances by debiting them and crediting the Income Summary account

2. Close out all the accounts that have debit balances by crediting them and debiting the Income Summary account

3. Close out the Income Summary account to the Capital account

4. Close out the Drawing account to the Capital account

Closing Entry #1: Close out the debit account(s) to the Income Summary account

Because sales, purchase discounts, purchase returns and allowances and ending inventory is a CR balance account, a DR entry is needed to close it off

  Date Particulars P.R. Debit Credit  

1  DEC

 31 Sales   XX  

2      Purchase Discounts    XX    

Purchase Returns and Allowances XX

3     Ending Inventory    XX      

Income Summary XX

To close income statement accounts with a credit balance, and establish ending inventory

Closing Entry #2: Close out the debit account(s) to the Income Summary account

  Date Particulars P.R. Debit Credit  

1  DEC

 31 Income Summary   XX  

2     Sales Discounts      XX

Sales Returns and Allowances XX

3     Purchases        XX  

Freight-In XX

Freight-Out XX

Any Other Expenses XX

Beginning Inventory XX

To close income statement accounts with a debit balance, and remove the beginning inventory balance

Closing Entry #3: Close out the Income Summary account to the Capital account

If the Income Summary account has a CR balance, then a DR entry is needed to close it. (profit capital increases)

If the Income Summary account has a DR balance, then a CR entry is needed to close it. (loss capital decreases)

  Date Particulars P.R. Debit Credit  

1  DEC

 31  Income Summary   XX   1

2     K. Smith Capital       XX 2

Closing Entry #4: Close out the Drawing account to the Capital account

Because Drawings is a DR balance account, a CR entry is needed to close it

HOW DO WE DO THIS?HOW DO WE DO THIS? At the end of each month, there is an order in which we close out accounts

1. Close out the sales account that has a credit balance by debiting it and crediting the Income Summary account

2. Close out all the accounts that have debit balances by crediting them and debiting the Income Summary account

3. Close out the Income Summary account to the Capital account

4. Close out the Drawing account to the Capital account

Closing Entry #1: Close out the sales account to the Income Summary account

Because sales is a CR balance account, a DR entry is needed to close it off

  Date Particulars P.R. Debit Credit  

1  DEC

 31 Sales   XX  

Income Summary XX

To close income statement accounts with a credit balance

Closing Entry #2: Close out the debit account(s) to the Income Summary account

  Date Particulars P.R. Debit Credit  

1  DEC

 31 Income Summary   XX  

2     Sales Discounts      XX

Sales Returns and Allowances XX

3     COGS        XX  

Freight-Out XX

Any Other Expenses XX

Inventory Shortage XX

To close income statement accounts with a debit balance

Closing Entry #3: Close out the Income Summary account to the Capital account

If the Income Summary account has a CR balance, then a DR entry is needed to close it. (profit capital increases)

If the Income Summary account has a DR balance, then a CR entry is needed to close it. (loss capital decreases)

  Date Particulars P.R. Debit Credit  

1  DEC

 31  Income Summary   XX   1

2     K. Smith Capital       XX 2

Closing Entry #4: Close out the Drawing account to the Capital account

Because Drawings is a DR balance account, a CR entry is needed to close it

Homework› Page 254- #15 a, #16 › Page 312 #12b, c, d