Accounting Cycle IV

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Accounting Cycle IV
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Lecture Outline

• Closing Entries
• Defined
• Closing Revenue Accounts
• Closing Expense Accounts
• Allocation of Profit/Loss (Partnership)
• Fixed Capital Balance Method
• Closing Drawings Account

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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.

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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.

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Closing Revenue Accounts

• Revenue accounts are closed by debiting the
  revenue account by the amount of the closing
  balance and then crediting the PL 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 PL Summary account
  would be credited by 60,000.

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Closing Revenue AccountsGeneral Journal Entry

• Debit Credit
• Sales Revenue 60,000
• PL Summary 60,000

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Closing Expense Accounts

• Expense accounts are closed by crediting the
  expense account by the amount of the closing
  balance and then debiting the PL 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 PL Summary account debited by 10,000.

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Closing Expense AccountsGeneral Journal Entry

• Debit Credit
• PL Summary 10,000
• Wages Expense 10,000

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Closing the PL Summary

• The PL Summary is a temporary account. It is
  closed off to the Profit Distribution account at
  the end of the accounting period.

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Closing the PL Summary

• Example
• Novel Sports has made a 50,000 profit (ie
  60,000 10,000) then the PL Summary will have
  a 50,000 credit balance. This needs to be
  closed off to the profit distribution account

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Closing the PL Summary

• Debit Credit
• PL Summary 50,000
• Profit Distribution 50,000

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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.

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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.

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1. Fixed Ratio

• The partnership agreement specifies that net
  profit is to be allocated on the following basis
  (60 Justin, 40 Matt).
• Debit Credit
• Profit Distribution 50,000
• Retained Profits - Justin 30,000
• Retained Profits - Matt 20,000

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Statement of Financial PositionEquity

• Equity
• Capital - Justin 200,000
• Capital - Matt 150,000
• Retained Profits- Justin 30,000
• Retained Profits - Matt 20,000
• Total Equity 400,000

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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.

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2. Ratio Based on Capital Balances

• Justin 200/350 x 50,000 28,571
• Matt 150/350 x 50,000 21,429
• Debit Credit
• Profit Distribution 50,000
• Retained Profits - Justin 28,571
• Retained Profits - Matt 21,429

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Statement of Financial PositionEquity

• Equity
• Capital Justin 200,000
• Capital - Matt 150,000
• Retained Profits- Justin 28,571
• Retained Profits - Matt 21,429
• Total Equity 400,000

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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).

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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 profit
• Justin 10 x 200,000 20,000
• Matt 10 x 150,000 15,000

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Profit Distribution
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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.

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Profit Distribution
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3. Fixed Ratio after Interest on Capital and
Salaries

• The remaining profit (5,000) is then allocated
  according to fixed ratio (ie 46)
• Profit allocated to each partner from profit
• Justin 60 x 5,000 3,000
• Matt 40 x 5,000 2,000

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Distribution of Profit

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

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Statement of Financial PositionEquity

• Equity
• Capital - Justin 200,000
• Capital - Matt 150,000
• Retained Profits- Justin 30,000
• Retained Profits - Matt 20,000
• Total Equity 400,000

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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 period
• Justin 9,000
• Matt 6,000

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Closing Drawings

• Debit Credit
• Retained Profits - Justin 9,000
• Retained Profits Matt 6,000
• Drawings - Justin 9,000
• Drawings Matt 6,000

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Statement of Financial PositionEquity

• Equity
• Capital Justin 200,000
• Capital - Matt 150,000
• Retained Profits- Justin 21,000
• Retained Profits - Matt 14,000
• Total Equity 385,000