Chapter 3
Preparation
of Financial
Statements
Closing
entries
1
Close the Books
Prepares the accounts for the next period
Close temporary accounts: accounts related to a limited
period of time
• Revenues
•Expenses
• Dividends
Do NOT close permanent accounts
• Assets
•Liabilities
• Stockholders’ equity 2
Close the Books
Steps
to
close
the
books:
Debit each revenue for the amount of its
credit balance. Credit Retained Earnings
for the sum of all revenues.
Credit each expense account for the
amount of its debit balance. Debit Retained
Earnings for the sum of all expenses.
Credit the Dividends account for the
amount of its debit balance. Debit Retained
Earnings for the same amount.
3
Closing Entries - RevenuesClosing Entries - Revenues
Dr. Sales Revenue $50,000
Cr. Retained Earnings $50,000
(To close out sales revenue account at the end of the period)
4
Dr. Cr. Dr. Cr.
Sales Revenue
Account
Retained Earnings
Account
$50,000Retained
Earnings
account
$50,000Sales
Revenue
account
Balance$50,000
Zero Balance
Closing entries - ExpensesClosing entries - Expenses
Dr. Retained Earnings $1,000
Cr. Utilities Expense $1,000
(To close out utility expense account at the end of the period)
5
Dr. Cr. Dr. Cr.
Retained Earnings
Account
Utilities Expense
Account
$1,000Utilities
expense
account
$1,000Retained
Earnings
account
ALL REVENUE AND EXPENSES ACCOUNTS MUST BE CLOSED –
BALANCE IN THESE ACCOUNTS MUST BE ZERO
Balance $1,000
Zero Balance
Closing entries - DividendsClosing entries - Dividends
Dr. Retained Earnings $500
Cr. Dividends $500
(To close out dividends at the end of the period)
6
Dr. Cr. Dr. Cr.
Retained Earnings
Account
Dividends
Account
$500Dividends
account
$500Retained
Earnings
account
DIVIDENDS MUST BE CLOSED – BALANCE IN THIS ACCOUNT
MUST BE ZERO
Balance $500
Zero Balance
Closing entries – netting Closing entries – netting
Dr. Sales Revenue 50,000
Cr. Salaries expense 12,000
Cr. Utilities expense 5,000
Cr. Interest expense 3,000
Cr. Retained Earnings 30,000
(entry to close out revenue and expense accounts to retained
earnings at the end of the year)
7
Consider the following accounts and their closing
balances:
1. Sales revenue account - $50,000 (Cr)
2. Salaries expense account - $12,000(Dr)
3. Utilities expense account - $5,000(Dr)
4. Interest expense account - $3,000(Dr)
Credit to Retained Earnings = NET INCOME for
the year
Post Closing Trial BalancePost Closing Trial Balance
Debit Credit
Cash 1,000
Accounts Receivable 15,000
Accounts Payable 1,000
Loan 10,000
Common Stock 1,000
Retained Earnings 4,000
Sales 0
Wages expense 0
Rent expense 0
TOTAL 16,000 16,000
8
Single-Step Income Statement
Period of time
Single-Step Income Statement
Period of time
Revenues $$$
Less: expenses ($$)
Net income $$
Only one total
(no subtotals)
Operating revenues
Cost of Goods Sold (COGS)
Gross Profit/Margin
Operating expenses:
– General and
administrative expenses
– Selling expenses
= Operating Profit/Income
+/– Other revenues and expenses
= Income before taxes
–Income tax expense
= Net income/earnings/profit
THREE
important
subtotals
+
Net Income
Total
Multi-Step Income StatementMulti-Step Income Statement
Period of TimePeriod of Time
Statement of Retained Earnings (R/E)
Period of time (Accrual based)
Beg. R/E + Net Income – Dividends = End. R/E
Statement of Retained Earnings (R/E)
Period of time (Accrual based)
Beg. R/E + Net Income – Dividends = End. R/E
1. Shows CHANGES in the components of R/E
Net income/(net loss) and Dividends
Beginning retained earnings
+ Net income
– Dividends
Ending retained earnings
3. Shows the TOTAL AMOUNT invested by owners
through retention of profits (after dividend
payments).
2. LINKS the Income Statement & the Balance Sheet
Balance Sheet - PresentationBalance Sheet - Presentation
12
Listing of all assets, liabilities and
shareholders equity balances as of a specific
date
Classified Balance Sheet – classified into
Current and Long-term assets and liabilities
Current assets – short life – less than one year
– all other assets are long-term
Current liabilities – due within one year – all
other liabilities are long-term
Balance Sheet – Horizontal or Vertical Form
The Balance Sheet - Horizontal Format
Balance Sheet as of December 31, 20XX
ASSETS LIABILITIES
Current Assets: Cash $ 15,000 Accounts payable $ 30,000
Accounts receivable $ 36,000 Income taxes payable $ 6,000
Inventory $ 18,000 Bonds Payable $ 50,000
Total current assets $ 69,000 Total liabilities $ 86,000
Plant property and
equipment
$101,000 Common Stock $ 5,000
Investments $ 30,000 Retained Earnings $119,000
TOTAL ASSETS $200,000 TOTAL LIABILITIES
AND SHAREHOLDERS
EQUITY
$200,000
13
Financial Statement Articulation
Revenues $ 2,990,520
Expenses 2,821,498
Net income $ 169,022
Income Statement end. 1/30/XX R/E 1/31/xx $ 1,694,161
Net income 169,022
Dividends ( 83,906)
other ( 15,228)
R/E 1/30/xx $1,764,049
Stmt of Retained Earnings end. 1/30/XX
Cash $ 693,960
Other 1,444,188
Total $ 2,138,148
Liabilities $ 559,631
Common stk. 290,765
Other (476,297)
R/E 1,764,049
Total $ 2,138,148
Balance Sheet as of 1/30/XX
Cash--Op. Act. $ 386,462
Cash--Inv. Act. ( 49,069)
Cash--Fin. Act (119,805)
Exchng rates 3,030
Net increase $ 220,618
Beg. cash 473,342
End. cash $ 693,960
Cash Flow Statement end. 1/30/XX
