Question

Anne Marie, the owner of Anne’s Beauty Salon, comes to see you again. She tells you that she has one more question for you.  
She told you that her accountant tried to explain to her the closing process in the accounting cycle. The more he talked, the more confusing it got. How would you explain the closing process to Anne Marie?

She also asked about dividends. What are they? Will they increase expense?

Anne's Beauty Salon, Inc			Note, Income Statements should be monthly. This Income Statement is for training purposes, ONLY!
Income Statement
For the Year 2015
Sales (Revenue)	$    125,000.00
Cost of Sales	$      25,000.00
Gross Profit	$    100,000.00
Payroll Expense	$      67,500.00
Sales, General, Administrative Expense	$         5,000.00
Rent Expense	$         1,400.00
Utilities Expense	$         1,670.00
Insurance Expense	$            500.00
Depreciation Expense	$         2,500.00
Total Operating Expense	$      78,570.00
Total Operating Income	$      21,430.00
Taxes 30%	$         6,430.00
Net Income	$      15,000.00

Anne's Beauty Salon, Inc
Balance Sheet
At December 31, 2015
Assets			Liabilities
Current Assets			Current Liabilities
Cash		$               949.50	Accounts Payable	$         5,000.00
Accounts Receivable		$         11,948.00	Unearned Revenue	$             200.00
Supplies		$         20,500.00	Total Current Liabilities	$         5,200.00
Prepaid Rent		$           8,400.00
Prepaid Insurance		$           6,000.00
Total Current Assets		$         47,797.50	Note Payable	$       15,000.00
Equipment	$      25,000.00		Total Liabilities	$       20,200.00
Less: Accumulated Depreciation	$      (5,000.00)	$         20,000.00	Stockholders' Equity
Total Long-Term Assets		$         20,000.00	Common Stock	$       30,000.00
			Retained Earnings	$       17,597.50
Total Assets		$         67,797.50	Total Liabilities and Stockholders' Equity	$       67,797.50

Anne's Beauty Salon, Inc
Statement of Retained Earnings
For the Month Ending December 31, 2015
Retained Earnings, December 1	$              5,000.00
Add: Net Income	$           15,000.00
Subtract: Dividends	$           (2,402.50)
Retained Earnings, December 31	$           17,597.50

Answer 1

Closing process in an accounting cycle is the process of closing down the books of accounts that is separating the transactions of one accounting year from the transactions of the next accounting year. A lot of procedures are applied so as to ensure that the transactions are treated correctly. Any income not received but accrued should be treated as an income in the Profit and Loss Account and any expense not paid but accrued should be treated as an expense in the current accounting year itself. This is to make sure that the books of accounts and the financial statements give a true and fair view to the shareholders.

Cut-off procedures are applied so as to make sure the transactions are properly classified period-wise. Cut-off procedures mean the separation of transactions from one accounting year from the next accounting year.

We prepare closing entries for temporary accounts like the revenue and expense account. After the financial statements for the accounting year are prepared, the closing entries are recorded. The intention to record the closing entries is to ensure that each revenue and expense account begins with zero balance the next accounting year.

In a typical corporate set-up, the following are the procedures that are to be applied for closing the books of account of a financial year:

1. Close Revenues:

The first and foremost step that is involved is closing out all revenue accounts. The accountant shall review each revenue account and finds out each account with a balance. Companies record all transactions using debits and credits. Revenue accounts normally have credit balances. The accountant closes all the revenue accounts by debiting each account for the ending balance. The accountant credits an account called Income Summary for the total debits recorded for the revenue accounts.

2. Close Expenses :

The second step in the closing process involves closing all expense accounts. The accountant reviews each expense account and the accounts with a non-zero balance. Expense accounts normally have a debit balance. The accountant closes out the expenses by crediting each account for the ending balance. The accountant debits an account called Income Summary for the total credits recorded for the expense accounts.

3. Close Income Summary

During the closing process, the Income Summary account exists only for the purpose of zeroing the revenue and expense accounts. After closing the revenue and expenses accounts, the accountant needs to close the Income Summary account. The accountant determines the balance in this account by reviewing the first two closing entries.

Net income in the income statement = revenues - expenses.

This should equal the balance in the Income Summary account. If the Income Summary account has a debit balance, the accountant should credit this account for the balance and debit Retained Earnings. If the Income Summary account has a credit balance, the accountant should debit this account for the balance and credit Retained Earnings.

4. Close Dividends

The dividends declared during the accounting year should also be considered while closing the books of accounts. Dividends have a normal debit balance. The Dividend account is closed by crediting the Dividend account and crediting Retained Earnings for the balance.

Dividends. What are they? Will they increase expense?

In a typical corporate setup, the shareholders are the real owners of a company. It is the shareholders who have financed the company and they deserve to be given a share of the income that is earned by the company every year. Now, returns are provided to the shareholders in the form of dividends. They maybe defined as the return provided to the shareholders for investing their money in the company. A part of the profits maybe retained by the company and a part maybe distributed.

Yes, dividends increase expenses of the company. Tax is also payable on the amount of dividends payable.