Question

Closing entries are made at the end of an accounting period which requires that balance are transferred from temporary to permanent accounts.

Shelly is the office manager of a local medical practice. She has come to the end of the closing process and needs to prepare for the next accounting period. Shelly uses the 4-step closing process to close the temporary accounts.

1, What are the steps that Shelly must follow? Explain each step in the process.

2, Explain the significance of preparing financial statements after closing activities.

What is the benefit of preparing the post-closing trial balance and classified balance sheet after the closing entries are made?

Answer 1

1. The steps that Shelley must use:

a. Close the Revenue Accounts by transferring the credit balances in theses accounts to a clearing account known as Income Summary.

Debit Revenue Accounts, Credit Income Summary.

b. Transfer the debit balances in the Expense Accounts to the Income Summary.

Debit Income Summary, Credit Expense Accounts.

c. Closing the Income Summary by transferring the balance to Retained Earnings.

Debit Income Summary, Credit Retained Earnings ( In case of net income)

d. Closing the Dividends Account by transferring the debit balance of the Dividends Account to Retained Earnings.

Debit Retained Earnings, Credit Dividends.

2. The closing activities are related only to the temporary accounts. All the temporary accounts other than divideds are recognized in the Income Statement to arrive at the operating results of the firm during the period, i.e net income or loss.

The net income or loss is then added or deducted to last year retained earnings in the Statement of Retained Earnings, and current year dividends are deducted therefrom to arrive at the ending balance of Retained Earnings.

The ending Retained Earnings then are carried in the Balance Sheet as part of Stockholders' Equity.

The Statement of Retained Earnings therefore acts as a connecting cord between the Income Statement and the Balance Sheet.