accounting cycle iv. lecture outline closing entries defined closing revenue accounts closing...

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Accounting Cycle IV

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Page 1: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

Accounting Cycle IV

Page 2: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

Lecture Outline

Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts

Allocation of Profit/Loss (Partnership) Fixed Capital Balance Method

Closing Drawings Account

Page 3: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

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.

Page 4: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

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.

Page 5: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

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.

Page 6: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

Closing Revenue AccountsGeneral Journal Entry

DebitCredit

Sales Revenue 60,000

P&L Summary 60,000

Page 7: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

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.

Page 8: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

Closing Expense AccountsGeneral Journal Entry

DebitCredit

P&L Summary 10,000

Wages Expense 10,000

Page 9: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

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.

Page 10: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

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

Page 11: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

Closing the P&L Summary

DebitCredit

P&L Summary 50,000

Profit Distribution 50,000

Page 12: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

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.

Page 13: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

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.

Page 14: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

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

Page 15: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

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

Page 16: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

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.

Page 17: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

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

Page 18: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

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

Page 19: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

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).

Page 20: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

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

Page 21: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

Profit Distribution

$50,000

Justin$20,000

Matt15,000

Page 22: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

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.

Page 23: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

Profit Distribution

$50,000

Justin$20,000

Matt$15,000

$7,000 $3,000

Page 24: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

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

Page 25: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

$50,000

Justin$20,000

Matt$15,000

$7,000

$3,000

Total$30,000

$3,000

$2,000

Total $20,000

Page 26: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

Distribution of Profit

DebitCredit

Profit Distribution 50,000 Retained Profits - Justin 30,000 Retained Profits - Matt 20,000

Page 27: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

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

Page 28: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

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

Page 29: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

Closing Drawings

DebitCredit

Retained Profits - Justin 9,000

Retained Profits – Matt 6,000

Drawings - Justin 9,000

Drawings – Matt 6,000

Page 30: Accounting Cycle IV. Lecture Outline Closing Entries Defined Closing Revenue Accounts Closing Expense Accounts Allocation of Profit/Loss (Partnership)

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