accounting cycle iv. lecture outline closing entries defined closing revenue accounts closing...
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Accounting Cycle IV
Lecture Outline
Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts
Allocation of Profit/Loss (Partnership) Fixed Capital Balance Method
Closing Drawings Account
Closing Entries
At the end of each new accounting period the balances within the revenue and expense accounts at the end of the old accounting period must be “closed off”.
“Closing Off the accounts” Simply means that accounts are returned to a
zero balance.
Closing Entries
Revenue and expense accounts are closed off to ensure that only revenues earnt and expenses incurred within a period are included within the Statement of Financial Performance.
Closing Revenue Accounts
Revenue accounts are closed by debiting the revenue account by the amount of the closing balance and then crediting the P&L Summary account by the same amount.
Example “Novel Sports” sells $60,000 worth of goods in the
period. The sales revenue account would be debited by $60,000 and the P&L Summary account would be credited by $60,000.
Closing Revenue AccountsGeneral Journal Entry
DebitCredit
Sales Revenue 60,000
P&L Summary 60,000
Closing Expense Accounts
Expense accounts are closed by crediting the expense account by the amount of the closing balance and then debiting the P&L Summary account by the same amount.
Example The wages expense for “Novel Sports” is $10,000.
The wages account needs to be credited by $10,000 and the P&L Summary account debited by $10,000.
Closing Expense AccountsGeneral Journal Entry
DebitCredit
P&L Summary 10,000
Wages Expense 10,000
Closing the P&L Summary
The P&L Summary is a temporary account. It is closed off to the Profit Distribution account at the end of the accounting period.
Closing the P&L Summary
Example “Novel Sports” has made a $50,000 profit (ie
$60,000 – 10,000) then the P&L Summary will have a $50,000 credit balance. This needs to be closed off to the profit distribution account
Closing the P&L Summary
DebitCredit
P&L Summary 50,000
Profit Distribution 50,000
Allocation of Profit/Loss
Three methods for allocating profit are as follows: Fixed ratio Ratio based on capital balances Fixed ratio after deducting interest on partners
capital and salaries paid to partners.
The manner in which profits are to be allocated should be outlined in the partnership agreement.
Example
Matt and Justin are partners in “Novel Sports”.
Capital Investments are as follows: Justin $200,000 Matt $150,000
Profit for the year is $50,000.
1. Fixed Ratio
The partnership agreement specifies that net profit is to be allocated on the following basis (60% Justin, 40% Matt).
Debit CreditProfit Distribution 50,000
Retained Profits - Justin30,000
Retained Profits - Matt20,000
Statement of Financial PositionEquityEquity
Capital - Justin 200,000
Capital - Matt 150,000
Retained Profits- Justin 30,000
Retained Profits - Matt 20,000
Total Equity 400,000
2. Ratio Based on Capital Balances Justin and Matt agree to share profit based
on opening capital balances.
In this way, the partner that has invested more money into the business receives a greater proportion of any profit or loss.
2. Ratio Based on Capital BalancesJustin: 200/350 x 50,000 = 28,571Matt: 150/350 x 50,000 = 21,429
DebitCredit
Profit Distribution 50,000 Retained Profits - Justin 28,571 Retained Profits - Matt 21,429
Statement of Financial PositionEquityEquity
Capital – Justin 200,000
Capital - Matt 150,000
Retained Profits- Justin 28,571
Retained Profits - Matt 21,429
Total Equity 400,000
3. Fixed Ratio after Interest on Capital and Salaries Partners may specify within the partnership
agreement that each partner is to receive the following: Interest on Opening Capital Salary
Interest and Salaries to partners are paid out of the profit (ie they are not expenses of the business).
3. Fixed Ratio after Interest on Capital and Salaries Matt and Justin agree that 10% interest on
opening capital should be paid each year.
Interest allocated to each partner from profitJustin: 10% x 200,000 = 20,000
Matt: 10% x 150,000 = 15,000
Profit Distribution
$50,000
Justin$20,000
Matt15,000
3. Fixed Ratio after Interest on Capital and Salaries The partners agree that Justin should receive
a salary of $7,000 and Matt a salary of $3,000.
Profit Distribution
$50,000
Justin$20,000
Matt$15,000
$7,000 $3,000
3. Fixed Ratio after Interest on Capital and Salaries The remaining profit ($5,000) is then
allocated according to fixed ratio (ie 4:6)
Profit allocated to each partner from profitJustin: 60% x 5,000 = 3,000
Matt: 40% x 5,000 = 2,000
$50,000
Justin$20,000
Matt$15,000
$7,000
$3,000
Total$30,000
$3,000
$2,000
Total $20,000
Distribution of Profit
DebitCredit
Profit Distribution 50,000 Retained Profits - Justin 30,000 Retained Profits - Matt 20,000
Statement of Financial PositionEquityEquity
Capital - Justin 200,000
Capital - Matt 150,000
Retained Profits- Justin 30,000
Retained Profits - Matt 20,000
Total Equity 400,000
Closing Drawings
At the end of the period any drawings by partners are closed off to the respective partners retained profit account.
Drawings by each partner during the periodJustin: 9,000
Matt: 6,000
Closing Drawings
DebitCredit
Retained Profits - Justin 9,000
Retained Profits – Matt 6,000
Drawings - Justin 9,000
Drawings – Matt 6,000
Statement of Financial PositionEquityEquity
Capital – Justin 200,000
Capital - Matt 150,000
Retained Profits- Justin 21,000
Retained Profits - Matt 14,000
Total Equity 385,000
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