Understanding Closing Entries in Accounting

Oct 1, 2024

Closing Entries in Accounting

Introduction

  • Presented by James
  • Focus on posting closing entries in two ways: Long Way and Short Way
  • Part of the accounting cycle, step 8
  • Importance: Resets temporary accounts to zero and transfers balances to retained earnings

Key Concepts

  • Closing Entries: Journal entries to reset temporary accounts at end of accounting period
  • Temporary Accounts: Revenue, Expenses, and Dividends (R-E-D)
  • Permanent Accounts: Assets, Liabilities, and Equity (A-L-E)
  • Income Summary Account: A temporary account used only during the posting of closing entries

Accounting Cycle Overview

  1. Closing entries are the final step (step 8)
  2. Occur after financial statements are created

Dealer and Red Ale

  • Dealer: Acronym for Debit and Credit accounts
    • Dividends, Expenses, Assets (Normal Debit accounts)
    • Liabilities, Equity, Revenue (Normal Credit accounts)
  • Red Ale: Acronym to remember temporary accounts (Revenue, Expenses, Dividends)

Understanding Trial Balance

  • An accounting report showing balances in each general ledger account
  • Can be filtered to show only accounts with current balances
  • Example: Unter (ride-sharing app) trial balance

Steps in the Long Way

  1. Reset Revenue Account
    • Transfer balance to the income summary account
    • Debit revenue and credit income summary
  2. Reset Expense Accounts
    • Transfer balances to income summary account
    • Credit expenses and debit income summary
  3. Clear Income Summary Account
    • Transfer net balance to retained earnings
    • Debit income summary, credit retained earnings
  4. Reset Dividends to Zero
    • Transfer to retained earnings
    • Credit dividends, debit retained earnings

The Short Way

  • Use one entry to reset all temporary accounts directly to retained earnings
  • Practical with modern accounting software

Post Closing Trial Balance

  • Shows account balances after closing entries
  • Transforms into next year's opening trial balance

Recap

  • Two methods to post closing entries: Long Way (manual systems) and Short Way (software)
  • Both methods lead to the same outcome in the post-closing trial balance

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Conclusion

  • Thank you for watching and support