CLOSING ENTRIES: Everything You Need To Know

Hey guys my name is James and in this quick video  i'm going to show you how to post closing entries   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   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   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   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   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   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   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   if we want to reset them to nil then we need to  post equal and opposite credits to each account   for cost of services, overhead expenses, interest  and tax and that leaves us with a total balancing   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   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   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   credit balance in the income summary account so  we need to debit it by the same amount and credit   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   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   after posting their closing entries you can  see that all of their temporary accounts   have been reset to zero and their balances  have been transferred to retained earnings   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   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   thank you one way you can do that is by  clicking on the join button below and   another way is by buying one of my cheat sheets  there's one for closing entries which covers   yeah everything we just went through thanks  for watching and i'll see you again soon!

Channel: Accounting Stuff

Views: 53,885

Rating: 4.9782314 out of 5

Keywords: closing entries, closing entry, closing journal, closing journal entries, post closing trial balance, accounting, accountingstuff, accountingbasics, how to closing entries, accounting tutorial, income summary, income summary account, permanent accounts, temporary accounts, red ale, dealer, retained earnings, closing entries tutorial

Id: e1z2lpdQyGQ

Length: 13min 58sec (838 seconds)

Published: Tue Dec 15 2020