 Hello and welcome to bootcamp part 4 of 5 for FAR CPA exam. In this session, we look at the closing entries. In the first session, we analyzed transaction using the account and equation. We learned about our T-account, journalized post to the ledger and we prepared the trial balance. In part two, we prepared adjusting entries. In part three, we prepared financial statements. Using the same data, we're gonna be preparing the closing entries. The closing entries is an important concept on the CPA exam, whether you are taking back a Roger, Gleam or Wiley, it does not matter. Knowing the closing process is important to your understanding. Now, they may not ask you specifically about journal entries that deals with the closing process. Well, so why am I learning about the closing process then? Well, when you have accounting changes, when we make errors, well, it depends whether we make the error this year or the prior year. So when you learn about those concepts, changes in accounting principles, changes in estimate, errors, you need to know the closing process. You need to know that if the accounts are closed, you can't go back and adjust them. You have to adjust something else, beginning retained earning. So understanding this concept will help you understand other concepts in accounting. So this is basically bootcamp or the basics of accounting information. Also, this session is very beneficial for students as a review of their financial accounting or students who are taking intermediate accounting because at the beginning of an intermediate accounting, you would review the accounting process and this is what I'm doing in those five part, five part series. So whether you are an accounting student or a CPA candidate, I strongly suggest you take a look at my website, farhatlectures.com. No, I don't replace your CPA review course. I'm a useful addition. I can add value to your preparation. I'm like a vitamin pill that's gonna help you do better. That's gonna strengthen you, prepare for the exam plus your CPA review course. Your risk is one month of subscription. Give me a chance. I have helped hundreds, if not thousands of students. If you don't like it, you cancel. You like it, you keep it. So your risk is one month. And if not for anything, take a look at my website to find out how well or not well your university doing on the CPA exam. I do have other accounting courses as well. All my review supplemental resources are aligned with your CPA review course, whether you're taken back to Roger Gleam. I do have all the previously AI CPA released questions. Please take a look at my website. Connect with me on LinkedIn if you haven't done so. Like this recording, share it. Connect with me on Instagram, Facebook, Reddit and Twitter. So using this trial balance, we are going to prepare the closing entries. Now this trial balance, we started with zero for all these accounts. We prepare the unadjusted trial balance. We prepare the adjustments. Then we prepare the adjusted trial balance. Then we prepare the financial statements. And now we are ready to close. What does it mean we are closing? What is the purpose of closing the accounting record? Well, the purpose is simple. We have to zero out certain account. We have to close certain account every period, every accounting period. Now understanding why we close the account, understanding the concept will help you understand the whole process from A to Z. The process is straightforward, simple as long as you understand it. So let's talk about the accounting period. Remember, we have a principle called the periodicity principle. And what that principle does, it will take the life of the company and it will break it down into artificial periods like year one, year two, year three, year four, so on and so forth. Or you could break it down by quarter or monthly. It doesn't matter. At some point we have to stop and determine our profitability. We have to stop and determine whether we incurred a loss or are we making a profit in this company on a periodic basis. Because of that, when we start the new period, so when we go from period one to period two, we have to start again because now we are measuring our performance in period two. Think of the closing process as an odometer in your car. When you go on a trip, you would reset this odometer. You will reset it down to zero. Then you will start your trip and this odometer will start to count. Now once you're done, let's assume you're driving from New York to Florida. Once you arrive to Florida, then you say, okay, I'm done with my trip. Then you would reset and it takes more than 144 miles or kilometers. But the point is you got the point. So every time you start a new trip, you reset your odometer because you want to know how long it's taken you on that trip. Same concept applies to accounting. Every time you want to start a new period, you have to reset certain accounts. Now the question is, which accounts are we going to reset? That's important. Once you understand which accounts and why, the process is very, very simple, very simple to understand and to apply for that matter. Let me ask you this question. Let's keep this one, two, we need three and four. Let me ask you, I want you to tell me how much profit you made in period one or year one. Well, what do you do? Well, hopefully you remember from your financial statements, you'll take your revenues minus your expenses and you will get to net income. And this is year one. And if you remember from year one, our revenues were 15,000, our expenses was 13,500. I don't remember our expenses, how much they were, it doesn't matter, we just add them up here. The point is, no, 11,350, I believe, 11,350, 11,350, I believe. And the profit was 3,650. Let's just assume those were the numbers. If I ask you, tell me what's your profit in year two? When you want to count the profit in year two, you cannot count any profit from year one. In other words, show me how you did in year two. I understand what you did in year one. That's done, that's over. No, I need to see year two. So what does that mean? It means when you start year two, you have to bring revenues and expenses to zero and start from the beginning. What am I saying? What I'm saying is revenues and expenses, those accounts here are closed every year. Why? Because every year we need to measure our profitability. We need to find out how well we are doing. Well, we have to look at our revenues and expenses so we cannot bring anything from the prior period because we have to account for each period separately. So you just know, I just told you revenues and expenses. Let's talk about cash. Would you reset your account of cash to zero every year? Well, would that be in your interest, first of all? No, you don't reset cash because if you reset cash, it means, or if you close cash, it means you want your cash account to be zero. Why? You have 68,000 in cash. You don't say, well, it's a new period. I have zero account. Same thing with account receivable, you have 8,000. Well, you don't say, well, you know what? I am not going to, you know, my customers owe me $8,000. It's a new accounting period. I'm gonna forgive them. I'm gonna reset it down to zero. Would you do that? And the answer is no. Same thing for supplies. If you have 500 worth of supplies, prepaid equipment, it's not in your interest to reset them down to zero. Just not, okay? So assets, we don't close. So assets, and basically you don't close because logical, you don't want to close them. You have those assets. You don't wanna say I have zero assets because it's a new period. You have those real assets and they're called real, real accounts. They're permanent, real. Now, let's look at our liabilities. You have notes payable at the bank of 40,000. Can you contact the bank and say, you know what? I'm starting this new accounting period. And guess what? Because I'm gonna reset all my account down to zero. No, I don't owe you anything. Would you like to do that? Of course you would like to do that. Can you do that? And the answer is absolutely not, okay? So you cannot just tell the bank, I'm gonna reset your account down to zero. You can do that. Same thing to your suppliers. You owe them 2,000. You cannot just tell them, you know what? Just, you know, don't, don't, don't, don't bill me anymore because I have a new accounting period. And because of that, I am not going to, I am not going to pay you. So you can't do that. Same thing with unearned service revenue. If you owe someone money, guess what? You have to go back. I'm sorry, not money. If you owe them services, you have to go back and tell them, look, I'm gonna deliver my service. Just give me some time. Can I just tell them it's a new accounting period? Well, you got the point. Liabilities are also real. So assets and liabilities, they are real account or we call them permanent account. Permanent versus temporary, okay? And nominal versus real. Those, this is real. These accounts here are nominal, okay? We have nominal account and real account. Real account stays and I showed you why. Nominal account, they go away. Simply put, let me make it easier for you. Anything that goes on the balance sheet is a real account. So anything but balance sheet are closed. Which accounts are closed? Anything but balance sheet. What does that mean? It means all the balance sheet account are real. So anything else is not real. So what's not real? Dividend. Dividend is also a nominal account. What is dividend? Dividend is the withdrawal that you make from the company every year or the company that distributes part of the profit every year. Dividend is part of their income. So every year you're gonna distribute some of that profit. So from year to year, you have to keep track of that account. So every year you would reset it down to zero. So everything else is real other than, I'm sorry, everything else other than the balance sheet account are nominal. So basically all these accounts, they have to go away. And you will see the process in a moment. And all these accounts, we call them real. Common stock, assets, liabilities, okay? Don't worry, let me clear this and I'll show you the process how we do this. Very easy, simple process. Four step process. I'm gonna start with step one, step two, step three, step four. Step one, you close all your revenue account to income summaries. Now, first, you ask yourself, what is my revenues? Well, I have a service revenue here. Okay, service revenue. And I have in service revenue 15,000. Simply put from a T account perspective, I have revenues or service revenues or consulting revenues, whatever you want to call them. I'm just gonna call them revenues because you could have many type of revenues. You have 15,000. What you need to do now, you need to close it. So I need to bring this account down to zero. So I need to debit this account 15,000, bring it down to zero. For every debit, I need a corresponding credit. What we're saying, close it to income summary. So we're gonna create an account called income summary. And since I debit the revenue, I'm gonna credit income summary. I'm basically done with step one. So I'm gonna debit the revenue, call it consulting service, whatever you wanna call it, credit income summary. Now on some textbook or some CPA review courses, they close it directly to retained earning. That's acceptable as well. You have to understand that you can also close revenue directly to retained earnings. I'm gonna take it through a step through income summary just because I like to do that. But know that you can close it to retained earnings automatically. So simply put, you can debit revenue and credit retained earnings, the corresponding credit is retained earnings. We're gonna eventually do that. That's what's gonna end up happening, but I'm taking it through two steps. So basically I'm done with step one. And what I'm gonna do, I'm gonna take out revenues. So basically revenues are gone. Step two on the closing process, close expenses to income summary. So what does that mean? Expenses, they all have a debit balance. They all have a debit balance. So how do I close them? Well, if expenses have a debit balance, I have to credit them. So simply put, I'm not gonna credit them all. I'm just gonna put expenses. And what I'm gonna do, I'm gonna credit expenses. All the expenses, they have a debit balance. I'm gonna credit them. And I believe they'll end up to be, how much the balance, 11,350. So all these are 11,350. I'm gonna credit them. And I'm gonna close them to income summary. And I'm gonna debit income summary, 11,350. So this is the corresponding, this is the entry to close expenses, okay? So notice expenses, the zero should be on the debit side. Expenses are now down to zero. So I credit them all. I credit all the expenses. I credit salaries and wages, 6,000, debit income summary. I did it individually. Notice what I did each one individually. Okay, I just did them in a T account altogether to show you that they go down to zero. Now, let's discuss the income summary account. Simply put, I also closed the expenses. Those are gone too, gone, gone. Now I have this account called, I'm gonna abbreviate income summary. I have revenues of 15 on the credit side and the debit side of 11,350. The third step is to close income summary to retained earnings. Guess what? I debit income summary. Because right now I have an income summary, 3650. That's the balance. So I need to close it. I'm gonna debit income summary, 3650 to make it go down to zero. And I'm going to credit retained earning, 3650. I'm assuming retained earning has a beginning balance of zero. So what I did, I closed also income summary. So this account is also gone. So this 3650, maybe you remember this number. This 3650 is the same thing as net income because the difference between revenues and expenses is net income. And this is the account, net income. So you could always confirm because you need to close net income to retained earnings. And this is what I did. I closed net income to retained earnings. So hopefully you remember this figure. Revenues minus expenses. This is what we did in the prior session. We prepared the financial statement. So it's not a coincidence. That's exactly what we did. So this number 3650 is net income and it's close to retained earning to increase retained earning. That's step three. So we're done also with all the expenses. Now, I told you we need to also close dividend. How do we close dividend? That's step four. We close dividend directly to retained earnings. So we're gonna debit retained earnings and credit dividend because dividend has a debit balance. Dividend has a debit balance of 3,000. So I need to credit dividend 3,000. That's why I credited dividend. I credited dividend 3,000. Now dividend is gone and I transfer dividend to retained earnings. Let me show you this picture. This is basically the statement of retained earning. So if we look at the T account for retained earnings, if we are looking at a T account for retained earnings, the beginning retained earnings was zero. We added to it 3650 when we closed income summary. Then we reduced it by 3,000. The balance in retained earning is 650. And copy this number down 650. You will see it again shortly. Okay, so this is the closing process. And notice it's, this is basically the last step, completes the statement of retained earning by reducing retained earning by 3,000. And this is it. This is the closing process. But this is a powerful, powerful process in a sense of understanding this. But here's what happened. All these accounts are gone. All these accounts are gone. All the temporary accounts are gone. They're gone in a sense they are resetted down to zero. And guess where they went? They all went into this number 650. They all went into 650. So let me show you how they all went into 650. This is the old adjusted trial balance. Now what's gonna happen? I'm gonna list the accounts that we did not close. And this is called the post. Post means after closing. So this is the trial balance after closing all the temporary or all the nominal accounts. So what's left are the real account, real account, real or permanent. This is what's left. Okay, permanent. Now, what happened to the other accounts? What happened to revenues, expenses, dividend and all these accounts that are here? So what happened to these accounts? I showed you all these accounts. I closed them. But they didn't go away. I net them against each other. First, I netted all the expenses versus all the revenues and I ended up with 3,650. Then I netted this account to retained earnings. So when I net them against each other, what's left is 650. So notice what happened. All these accounts, all these temporary accounts are absorbed into this 650, into this 650. And that's why when we make an error, when we discover an error in 2020, 2025, the following year, we can go back and change the expenses. What we do is we adjust it to retained earnings. When we have changes in accounting principle, we adjust to retained earnings. Why? Because the other accounts are closed and that's what I was telling you at the beginning. These accounts are closed unless we discover the error in the same period, then we can fix the expense or fix the revenue. Okay, but any adjustments in future period, that's why we involve retained earnings. So this is basically the closing process in a nutshell, which is part four of four. So part one, two, three and four are simply the accounting cycle. Accounting cycle means what? It's we started by analyzing transaction, recording transactions, posting transactions, preparing a trial balance. We prepare the adjusting entries, financial statements. The last thing is we prepare closing entries. Then notice we prepare the post closing trial balance to start our new period. Now, in the next session, I will look at an important topic and that's very confusing to students. That's converting from cash to accrual. Well, how about accrual to cash? Yes, you would learn about accrual to cash when you prepare your statement of cash flows, which is there's a one-hole chapter about this, a lot of information. But also going from cash to accrual is something I believe you need to know, something important because it's important. I wanna make sure you know it, especially if you're studying for the CPA exam. You want to be comfortable going to the CPA exam. Going from cash to accrual or going obviously from accrual to cash, which is the statement of cash flow. At the end of this recording, I'm gonna remind you again, don't shortchange yourself. Invest in yourself, invest in your career. The CPA exam is a lifetime investment. I can help you pass. Take a look at my material, study hard. Good luck. The CPA is worth it. And of course, stay safe.