 Hello, and welcome to the session in which we would look at an example for closing entries. Why are closing entries important? Well for one thing you need to know them for your financial accounting, intermediate accounting and the CPA exam, however understanding the closing entries could help you understand how retained earnings work and what happened to what we called temporary accounts. So it's not only you want to know how the closing process occur, but you want to understand the concept, how it's being done, and what accounts are affected, and how everything affects the retained earnings. So let's take a look at this example to illustrate these concepts. ABC Company has year-end account balances of sales revenue 900,000, interest revenue 10,500, cost of goods sold 535, administrative expenses 210, income tax expense 38,100, and dividend of 20,000. Ending retained earnings is 105, so I'm going to ask you to prepare the journal entries for the closing and compute the ending retained earnings. Now why is this example straightforward and simple? For one thing, I'm giving you all temporary accounts. What does that mean? It means all the accounts that are listed in this example, such as sales revenue, interest revenue, cost of goods sold, administrative expenses, income tax expenses, as well as dividend, are considered temporary account. Temporary means we close them. We close them at the end of the accounting period. You have to be careful on your exam. You might be giving assets. You might be giving liabilities. You might be giving common stock. Well, those accounts are permanent. We don't close them. So the first thing in the closing process you need to understand is which of my accounts are temporary, which of my accounts are permanent. I'm going to give you a shortcut, a hint. Anything that goes on the balance sheet do not close. Anything that goes on the balance sheet do not close. So any account that's considered a balance sheet account, you don't close. Everything else gets closed. Why? Because everything else either goes on the income statement or the retained earnings statement. But you don't close retained earnings because retained earnings goes on the balance sheet ending retained earnings. So this is what you need to know. Now what is the closing process? Well the closing process consists of four steps. I'm going to go over four steps by illustrating this concept. Well the first step is to close any revenue, any revenue, or sometime they call them in your textbook or CPA review course, credit balance income statement. What does that mean? Well, we know that revenues, well hopefully we know this. We know that revenues will have a credit balance. Now also we need to know that in addition to revenues we could have gains. Revenues would also have a credit balance. So any credit balance income statement account gets closed. Now in this example we only have two accounts which are sales revenue and interest revenue that are considered revenue, which is income statement with a credit balance. Now let's take a look at sales revenue. If sales revenue is 900,000 credit balance, how do I make this go down to zero? Well what do I have to do? I'm going to have to debit this account 900,000 to make it go down to zero. So what do I do with these balances? I debit them. So I debit their balances, so this is the debit, this is the debit, and what do I credit? I credit income summary. Now certain textbook or certain CPA review courses what they do rather than crediting closing revenue to income summary, they close revenues to retained earnings. And if it's in your textbook or if it's in your CPA review course they are closing it to retained earnings, that's fine, close it to retained earnings, we're going to end up in the same place. But I'm going to be using income summary to illustrate the concept, to really explain the concept. So step one is to close your credit income statement balances to income summary, usually close revenues to income summary and this is what we just did. So we transferred, so our revenue accounts are gone for the next period. The whole amount is transferred to an account called income summary, this is step one. Step two in the closing process, remember we have four steps is to close all debit income statement balances to income summary. Well cost of goods sold, if you know anything about expenses, cost of goods sold will have a debit balance, so we'll have a debit balance of 535. And all expenses will have a debit balance. Now also in addition to the expenses we could have losses, they have a debit balance. Also we could have sales, returns and allowances, they will have a debit balance. So any debit balance of an income statement account, any of these debit balances, guess what? We are going to close them, so they all have debit balances. So how do we close the debit balance? How do we make a debit balance go down to zero? Well we credit that balance, therefore I'm going to credit cost of goods sold 535, therefore it's gone. I'm going to credit administrative expenses 210,000, that's gone too. I'm going to credit income tax expense 38,100. If I have a list of other expenses, losses, any debit balance accounts on the income statement, I credit them. Usually we don't credit expenses, that's not normal, but in the closing process we do. Now what do we debit? We are going to debit for the total income summary. So all these balances, we debit income summary. They get close to income summary. So all the expenses are gone. So we get rid of the revenues, we get rid of the expenses. That's fine. Once again, certain tax book or certain CPA review course, they debit retained earnings automatically, that's fine if they do that. Now so we're done with the expenses, we're done with revenues, they are all transfer. So these are all the revenues, these are all the expenses. What do we do next? Step three is to close income summary. So you need to find out what is your income summary account. Now if you have more credits than debits, you have a credit balance. So the difference between 9, 10, 500 and 73,100 is an income summary balance of 127,400. Now if the credit are revenues and the debit are expenses, well this number is also net income. So your net income is 127,400. Now what do we do with net income? We need to close it. It has a credit balance. How do we close credit balance? We are going to debit this credit balance. We are going to debit this credit balance. And where do we close net income? Where do net income ends up? The net income ends up and retained earnings. Therefore, I closed income summary and I transferred this account to retained earnings. So I increased retained earnings and hopefully this makes sense because net income increases retained earnings. So I'm done with step three. Step three is basically closing income summary. Now if you already, if you transferred everything to retained earnings, like as I told you some textbook would do, then you will not have this entry because everything was transferred to retained earnings and the net will be 127,400. This is step three. Step four in the closing process is closing dividend. How much dividend do we have? Well we have dividend of, dividend for this example of 20,000. Dividend will have a debit balance. So how do you close the dividend? Well we're going to debit retained earnings. We're going to reduce the dividend by 20,000. We're going to reduce retained earnings by 20,000 and credit the dividend because dividend has a debit balance. We need to credit to get a dividend. Now what we did is we transferred everything, dividend, revenues and expenses. Everything is transferred to retained earnings. Now I'm asking you compute the ending retained earnings. I compute the ending retained earnings and the answer is 212,400. So this is my ending retained earnings. So why is this exercise important? Why is it important? Well, because it shows you what happened to revenues, what happened to expenses, what happened to temporary accounts such as dividend. They all get transferred to retained earnings which is a permanent account. Retained earnings is a balance sheet account. So retained earnings is a very important account because it's a cumulative account. It keeps track of the company's income, income which includes revenues, expenses and dividend and obviously losses if you have losses rather than income over the years. I hope this recording was helpful and an understanding closing retained earning. What should you do now? Go to farhatlectures.com and work multiple choice questions that's going to help you understand, reinforce the concept. Good luck, study hard and stay safe. Before we proceed any further, I would like to remind you whether you are an accounting student or a CPA candidate to take a look at my website, farhatlectures.com. I don't replace your CPA review course nor your accounting courses. What I do is I'm a useful addition to your CPA review course. My motto is helping accounting students and CPA candidate by providing new resources, lectures, multiple choice, true, false, exercises. This is a partial list of my accounting courses. 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