Question

If today were Dec 31st, 2019,

1) What are temporary accounts? Would you close (zero out) temporary accounts of your business? Why?

2) How many steps in the closing process? Would you please describe each step?

Answer 1

1. Temporary accounts :-

A temporary account is an account that begins each fiscal year with a zero balance. At the end of the year, its ending balance is shifted to a different account, ready to be used again in the next fiscal year to accumulate a new set of transactions. Temporary accounts are used to compile transactions that impact the profit or loss of a business during a year. Examples of temporary accounts are:

Revenue accounts

Expense accounts (such as the cost of goods sold, compensation expense, and supplies expense accounts)

Gain and loss accounts (such as the loss on assets sold account)

Income summary account

The balances in these accounts should increase over the course of a fiscal year; they rarely decrease. The balances in temporary accounts are used to create the income statement.

At the end of a fiscal year, the balances in temporary accounts are shifted to the retained earnings account, sometimes by way of the income summary account. The process of shifting balances out of a temporary account is called closing an account. This shifting to the retained earnings account is conducted automatically if an accounting software package is being used to record accounting transactions.

2. Steps in closing process :-

In accounting, we often refer to the process of closing as closing the books. Only revenue, expense, and dividend accounts are closed—not asset, liability, Common Stock, or Retained Earnings accounts. The four basic steps in the closing process are:

A. Closing the revenue accounts—transferring the credit balances in the revenue accounts to a clearing account called Income Summary.

B. Closing the expense accounts—transferring the debit balances in the expense accounts to a clearing account called Income Summary.

C. Closing the Income Summary account—transferring the balance of the Income Summary account to the Retained Earnings account.

D. Closing the Dividends account—transferring the debit balance of the Dividends account to the Retained Earnings account.

Clear explanation of each step :-

Step 1: Close Revenue accounts

Close means to make the balance zero. We see from the adjusted trial balance that our revenue accounts have a credit balance. To make them zero we want to decrease the balance or do the opposite. We will debit the revenue accounts and credit the Income Summary account. The credit to income summary should equal the total revenue from the income statement.

Step 2: Close Expense accounts

The expense accounts have debit balances so to get rid of their balances we will do the opposite or credit the accounts. Just like in step 1, we will use Income Summary as the offset account but this time we will debit income summary. The total debit to income summary should match total expenses from the income statement.

Step 3: Close Income Summary account

At this point, you have closed the revenue and expense accounts into income summary. It should — income summary should match net income from the income statement.

Step 4: Close Dividends (or withdrawals) account

After we add net income (or subtract net loss) on the statement of retained earnings, what do we do next? We subtract any dividends to get the ending retained earnings. This will be the journal entry form of doing this calculation but be careful because you do not want to use the amount of retained earnings but DIVIDENDS. We want to decrease retained earnings (debit) and remove the balance in dividends (credit) for the amount of the dividends.

These are all the steps in closing of books of accounts.

These are all the information required to solve the given questions.

I hope, all the above mentioned information and explanations are useful and helpful to you.

Thank you.