CLOSING ENTRIES: Everything You Need To Know
Summary
TLDRIn this educational video, James teaches viewers how to post closing entries in accounting, detailing both a long and a short method. He explains the purpose of closing entries in resetting temporary accounts to zero and transferring balances to retained earnings. The video uses the example of a ride-sharing app, Unter, to illustrate the process step-by-step, from adjusting trial balances to creating financial statements, and finally posting closing entries to prepare for the next accounting period.
Takeaways
- đą Closing entries are an essential part of the accounting cycle, occurring as the final step after financial statements are prepared.
- đ They reset temporary accounts like revenue, expenses, and dividends to zero and transfer these balances to the retained earnings account.
- đ The acronym 'DEALER' helps remember which accounts are debit or credit, with 'RED ALE' (Revenue, Expenses, Dividends) being temporary accounts.
- đ Retained earnings, a permanent account, accumulates a company's profits for future use and is found on the balance sheet.
- đ A trial balance shows the current balances in every general ledger account and can be filtered to show only accounts with activity.
- đ The video provides a detailed example using a fictional ride-sharing app company called 'Unter' to illustrate the process.
- đ The adjusted trial balance reflects a true and fair view of a company's financial position after all transactions for the year have been posted and adjusted.
- đŒ The long method of posting closing entries involves four steps, including transferring balances to an income summary account before moving to retained earnings.
- đ The short method simplifies the process by clearing all temporary accounts directly to retained earnings in a single entry.
- đĄ Modern accounting software often automates the short method, making the process more efficient and less prone to errors.
- đ The post-closing trial balance, which shows the state of accounts after closing entries are posted, serves as the opening trial balance for the next accounting period.
Q & A
What are closing entries in accounting?
-Closing entries are journal entries that reset temporary accounts to zero and transfer their balances into retained earnings, which is a permanent account held in a balance sheet.
Why are closing entries important?
-Closing entries are important because they help prepare the financial statements for the next accounting period by resetting temporary accounts and ensuring that the retained earnings account reflects the current period's profits or losses.
What is the accounting cycle and where do closing entries fit in?
-The accounting cycle consists of eight steps, with closing entries being the last step (step 8). They are posted at the end of each accounting period after financial statements have been created.
What is the difference between temporary and permanent accounts?
-Temporary accounts, such as revenue, expenses, and dividends, are reset to zero at the end of each accounting period. Permanent accounts, like assets, liabilities, and equity, carry their balances forward from one period to the next.
What does the acronym DEALER stand for and how does it help in accounting?
-DEALER stands for Dividends, Expenses, Assets, Liabilities, Equity, and Revenue. It helps in remembering which accounts are normally debit (DEAL) and which are normally credit (ER).
What is the RED ALE trick mentioned in the script?
-The RED ALE trick is a mnemonic to remember which accounts are temporary: Revenue, Expenses, and Dividends are temporary accounts, while Assets, Liabilities, and Equity are permanent accounts.
Can you explain the process of posting closing entries using the 'long way' as described in the script?
-The 'long way' involves four steps: 1) Clear revenue to the income summary account, 2) Clear expenses to the income summary account, 3) Transfer the balance in the income summary account to retained earnings, and 4) Clear the current year dividends straight to retained earnings.
How does the 'short way' of posting closing entries differ from the 'long way'?
-The 'short way' involves a single closing entry that clears all temporary accounts (revenue, expenses, and dividends) directly to retained earnings, instead of using the income summary account as an intermediary.
What is an income summary account and why is it used?
-An income summary account is a temporary account used during the closing process to accumulate the balances of revenue and expense accounts before transferring the net balance to retained earnings.
What is a trial balance and how does it change after posting closing entries?
-A trial balance is an accounting report showing the current balances in every general ledger account. After posting closing entries, the trial balance will show all temporary accounts reset to zero and their balances transferred to retained earnings.
How does the process of posting closing entries affect the balance sheet and income statement?
-Posting closing entries affects the balance sheet by updating the retained earnings account with the net income or loss of the period. The income statement summarizes the performance over the period, showing revenue, expenses, and the resulting profit or loss.
Outlines
đ Understanding Closing Entries
In this introductory paragraph, James explains the purpose of the video, which is to demonstrate how to post closing entries in accounting using two methods: a long way and a short way. He emphasizes the importance of closing entries in the accounting cycle, specifically at step 8, where temporary accounts are reset to zero and their balances are transferred to retained earnings. James introduces key concepts such as journal entries, temporary accounts, and permanent accounts, using the acronym 'DEALER' to differentiate between them. He also mentions the 'RED ALE' trick to remember which accounts are temporary and which are permanent.
đ Trial Balance and Financial Statements
This paragraph discusses the trial balance for a business named Unter, highlighting its significance as an accounting report that shows current balances in all general ledger accounts. James explains that Unter's trial balance is an opening one, dated January 1st, marking the start of the new financial year. He differentiates between permanent accounts (assets, liabilities, equity) and temporary accounts (revenue, expenses, dividends), noting that the latter are reset to zero at the end of the accounting period. The paragraph sets the stage for understanding how these accounts interact in the financial statements, specifically the income statement, which summarizes Unter's performance over the year.
đ Steps to Post Closing Entries
In this section, James outlines the four steps involved in posting closing entries using the long method. He begins by resetting Unter's revenue account to zero, transferring its balance to the income summary account, which is a temporary account used solely for this purpose. He emphasizes the importance of identifying the correct revenue account, as there are multiple accounts with 'revenue' in their names. Following this, he discusses resetting all expense accounts to zero, detailing how to post equal and opposite entries to clear their balances. The paragraph concludes with the process of transferring the balance from the income summary account to retained earnings, illustrating how this reflects the company's profit for the year.
đ Finalizing Closing Entries
This paragraph continues the closing entry process with step four, where James explains the need to reset current year dividends to zero and transfer that balance to retained earnings. He clarifies that dividends represent profits distributed to shareholders, which reduces retained earnings. James details the closing entry required to reset the dividends account and its impact on retained earnings. He then introduces the post-closing trial balance, which shows the remaining balances in Unter's accounts after all temporary accounts have been reset to zero. This section emphasizes the completion of the closing process and sets up for a quicker method.
⥠The Short Way to Closing Entries
In this concluding paragraph, James introduces a quicker method for posting closing entries, which involves clearing all temporary accounts (revenue, expenses, and dividends) to retained earnings in a single entry. He revisits the adjusted trial balance to illustrate how this can be done efficiently. By debiting the revenue account and crediting the dividends and expenses accounts, all temporary accounts are reset to zero with one closing entry. James summarizes the long and short methods of posting closing entries, highlighting the advantages of modern accounting software that often automates this process. He encourages viewers to support his channel and mentions the availability of cheat sheets for further learning.
Mindmap
Keywords
đĄClosing Entries
đĄAccounting Cycle
đĄTemporary Accounts
đĄPermanent Accounts
đĄJournal Entry
đĄRetained Earnings
đĄIncome Summary Account
đĄTrial Balance
đĄDebit and Credit
đĄGeneral Ledger
đĄBalance Sheet
Highlights
Introduction to posting closing entries in two different methods: long and short ways
Explanation of the accounting cycle and the role of closing entries
Definition of closing entries as journal entries that reset temporary accounts to zero
Description of retained earnings as a permanent account on the balance sheet
Introduction to the DEALER acronym for remembering debit and credit accounts
Differentiation between temporary and permanent accounts using the RED ALE trick
Explanation of the trial balance and its significance in accounting
Example of a trial balance for a ride-sharing app business called Unter
Description of how temporary and permanent accounts change throughout the accounting cycle
Process of creating an adjusted trial balance after a year of transactions
Explanation of how revenue and expenses are reflected in the income statement
Details on how the balance sheet includes permanent and temporary accounts
Step-by-step guide to posting closing entries the long way
Explanation of the income summary account and its temporary nature
Process of transferring balances from temporary accounts to the income summary account
Clearing the income summary account balance to retained earnings
Final step of resetting current year dividends and their impact on retained earnings
Introduction to the quicker method of posting closing entries using one entry
Recap of the steps involved in posting closing entries both long and short ways
Discussion on the practicality of the two methods for manual and software-based accounting systems
Encouragement for viewers to support the channel and access additional resources
Transcripts
Hey guys my name is James and in this quick video i'm going to show you how to post closing entries Â
in two different ways
a long way and a short way a lot of you have been asking for this one so thanks for all your requests
and an extra special thanks to my channel members
your contributions helped me make this so without further ado
let's begin
this is the accounting cycle it shows us how financial accounting works in eight steps
closing entries are tucked away at the very end of the cycle in step 8
we post them at the end of each accounting period after we're done creating financial statements
but what are they exactly?
closing entries are journal entries that reset temporary accounts to zero
they transfer their balances into retained earnings which is a permanent account held in a balance sheet
remember a journal entry is a record of a financial transaction
and retained earnings are a businesses profits held for future use but what are temporary and permanent accounts?
let me show you
if you've watched my videos before then you're probably familiar with dealer
but if you're new here dealer is a handy little acronym that can help us remember debit and credit accounts
it stands for dividends, expenses, assets, liabilities, equity and revenue
dividends, expenses and assets are normal debit accounts
whereas liabilities, equity and revenue are normal credit accounts
but here's the thing some of these are temporary accounts
and some are permanent
any idea which is which? hmm... i'll grab a drink while we think about it
Got it?
no worries if not
here's a little trick to help you remember
red ale
revenue, expenses and dividends are temporary accounts
and assets, liabilities and equity are permanent accounts
well i don't know about you but i'll cheers to that actually it's a bit early... yeah we'll put that away...
you can find dealer and red ale on my closing entries cheat sheet
which i'll leave a link to down in the description just for you...
so permanent accounts
assets, liabilities and equity
these guys live in the general ledger and their balances are always carried forwards from one accounting period into the next
on the other hand
revenue, expenses and dividends are temporary accounts
these also belong in the general ledger but they only correspond to one accounting period Â
once that period's over they need to be reset to zero and we do that using closing entries
if none of this is making sense don't sweat it i think this example might help clear things up
Happy new year!
this is a trial balance for a business called Unter
a late comer to the world of ride sharing apps
a trial balance is an accounting report showing the current balances in every general ledger account
and this is an opening trial balance because the date is January 1st
the start of Unter's new financial year
if we flick back to the accounting cycle we find ourselves right here
at the very beginning
now let's see how Unter's temporary and permanent accounts change as we move around this
at the moment they have some assets, some liabilities and some equity
A-L-E which means that all of these are permanent accounts making up Unter's balance sheet
but hang on where's revenue, where's expenses and dividends?
trial balances often have filters applied so that they only show accounts with numbers in them
if we expand this out then we find the usual suspects
revenue, expenses and dividends R-E-D
these are Unter's temporary accounts which were reset to zero at the end of last year
okay great now let's skip through steps one to six and get onto the good stuff Â
the adjusted trial balance
Unter drivers have been diligently moving customers from a to b for a whole year now
and we find ourselves at December 31st
here's Unter's adjusted trial balance
a whole year's worth of transactions have been posted and adjusted so that this represents a true and fair view of their business
as you can see all of the temporary R-E-D accounts have got numbers in them now these show us the revenue that Unter has earned
the expenses that it's incurred and the dividends that it's declared during the past year
now Unter can create some financial statements
revenue and expenses are temporary accounts that make up Unter's income statement
this summarizes Unter's performance over a one year period
we can see that they've made a tidy profit of three million nine hundred and fifty thousand dollars
but while the income statement only looks at revenues and expenses Unter's balance sheet is made up of everything
all of Unter's permanent and temporary accounts belong in here
assets, liabilities and equity are permanent accounts whereas current year dividends is a temporary account
and current year profit feeds directly through to here from the income statement
which as we saw is made up of temporary revenue and expense accounts
Unter has earned three million nine hundred and fifty thousand dollars in profit and they've declared half a million dollars in dividends Â
step eight
time to post the closing entries
i'm going to show you two ways to do this
the long way and the short way
the long way involves four steps and we'll move through these one by one
in step one we're going to reset Unter's revenue account to zero by transferring the balance Â
to the income summary account
what is an income summary account?
it's a very special, very temporary account that only exists while we're posting closing entries
and it works a bit like this
if we go back to the adjusted trial balance we're going to reset revenue to zero
but be careful with this because i can see three accounts with revenue in their descriptions
accrued revenue, deferred revenue and revenue revenue
accrued revenue is an asset and deferred revenue is a liability
they are both permanent accounts that we use for adjusting entries so we can leave them alone for this example
we're only interested in this temporary revenue account
so let's take a closer look at it
Unter earned 20 million dollars this year
this sits on the right hand side of their revenue t account
because revenue is a normal credit account
think dealer
we want to reset this temporary account to zero
so we need to post a closing journal entry on December 31st
we'll debit revenue by 20 million dollars and credit the income summary account by the same amount
as you can see this transfers the balance from the revenue account to the income summary account
so we're left with zero dollars in revenue and 20 million dollars in the income summary account Â
step two
now we need to do the same thing again but this time with all of the expense accounts
we'll reset them to zero and clear their balances to the income summary Â
account Unter has four different expense accounts
cost of services, overhead expenses
interest and tax
we can ignore accrued expenses because it's a permanent liability account
we need to post another closing entry and repeat what we did back in step one
expenses are normal debit accounts so their balances are on the left of these t accounts Â
if we want to reset them to nil then we need to post equal and opposite credits to each account Â
for cost of services, overhead expenses, interest and tax and that leaves us with a total balancing Â
amount of 16 million fifty thousand dollars which we'll debit to the income summary account
in every journal the total in the debit column has to match the total in the credit column
when we post this one we credit the right hand side of each expense account resetting all of them to zero
and we debit the left hand side of the income summary account now it's got a new balance of
three million nine hundred and fifty thousand dollars which is a net credit sitting on the right hand side Â
sound familiar?
it should do because this number is exactly the same as Unter's profit for the year which we saw in their income statement
step three it's time for us to clear out that balance in the income summary account and put it where it belongs
retained earnings which is a permanent equity account in Unter's balance sheet
back to our trial balance here's our income summary account and it has a three million nine hundred and fifty thousand dollar credit balance Â
which is a combination of Unter's revenues and expenses for the year
the closing entry for this one is nice and simple we have a three million nine hundred and fifty thousand dollar Â
credit balance in the income summary account so we need to debit it by the same amount and credit Â
the balance to retained earnings
when we post this Unter's retained earnings or their profits held for future use
increases to $13,950,000
and... bye bye income summary account
sorry this just isn't working out between us you know you're going to make a lucky accountant really happy someday
so job done right?
not quite
step four
we need to reset current year dividends to zero and clear the balance to retained earnings
Unter declared half a million dollars of dividends this year
these are the businesses profits that they've chosen to distribute to the owners of the business
it's shareholders and we know retained earnings are a businesses profits held for future use
so if Unter issues dividends then it's not holding on to these profits anymore
so its retained earnings are going to go down
as you'll see right now
Unter has five hundred thousand dollars of dividends which is a normal debit account so in this closing entry we're going to credit the dividend account
by five hundred thousand dollars and debit retained earnings by the same amount
when we post this closing entry Unter's dividends are reset to nil and its retained earnings Â
decrease to $13,450,000
just as we predicted
now can i get a drumroll please...
this is Unter's post closing trial balance it shows us what's left in each of Unter's accounts Â
after posting their closing entries you can see that all of their temporary accounts Â
have been reset to zero and their balances have been transferred to retained earnings Â
gee... that took a while didn't it?
thankfully there's a quicker way
the short way
this time we're going to take all of Unter's temporary accounts its revenue, expenses and dividends and clear their balances to retained earnings
using one closing entry so let's rewind and go back to the adjusted trial balance
here are Unter's temporary accounts we have revenue in the credit column and we have dividends and expenses in the debit column
we can reset all of these to zero using one closing entry
by debiting the revenue account and crediting the dividend and expense accounts
the balance of three million four hundred and fifty thousand dollars is credited to retained earnings
because in double entry accounting there are at least two equal and opposite sides to every Â
transaction when we post this closing entry all of the temporary accounts are reset to zero
fantastic!
we covered a lot there didn't we?
so here's a quick recap
when we post closing entries the long way there are four steps
first we clear revenue to the income summary account
then we clear expenses to the income summary account
then we clear the balance in the income summary account to retained earnings
and finally we clear the dividends straight to retained earnings
this might seem like a bit of a faff but if you're using a manual accounting system then the income summary account
can help you methodically work your way through this closing process
with the short way we clear all of these temporary accounts to retained earnings in one go often this happens automatically if you're using modern accounting software
but whichever method you're using we get to the same post-closing trial balance which usually looks like this
filtered to hide accounts with zero balances the post closing trial balance for this year becomes next year's opening trial balance
if you're enjoying these videos and you'd like to help support the channel well Â
thank you one way you can do that is by clicking on the join button below and Â
another way is by buying one of my cheat sheets there's one for closing entries which covers Â
yeah everything we just went through thanks for watching and i'll see you again soon!
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