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Accounting Examples – End of Month Closing

Closing the Accounts

At the end of the period, temporary or nominal accounts are closed; these include expense, revenue, and owner withdrawing accounts. This process zeros out the account balances so that the balance of the transactions in each account reflects only the transactions of a particular period. This is normally done only at the end of the year.

To facilitate closing, a clearing account called Income Summary is used. The Income Summary account is used only momentarily; revenue and expensed are closed into it and then that balance is immediately closed out to Owner’s Equity (or Retained Earnings). The four steps in closing the accounts are:

  1. Close revenue accounts by debiting each for its credit balance and crediting Income Summary.
  2. Close expense accounts by crediting each for its debit balance and debiting Income Summary.
  3. Income Summary is closed into the Capital account by debiting (for a net income) or crediting (for a net loss) the balance.
  4. Close the Withdrawals account by crediting it by its balance and debiting the Capital account.

In the example of closing journal entries below, assume that revenue, expense, and owner equity accounts have the following balances.

AccountBalanceAccountBalance
ExpensesRevenue
Rent Expense1,400Sales Revenue6,000
Salary Expense1,200Owner’s Equity
Office Supplies Expense400Capital Account9,000
Utilities Expense320Withdrawals1,000

The entries below depict a net income for the period. Read below how the entries differ for a net loss.

General JournalPage: 1
DateAccount Titles/ExplanationRefDebitCredit
20XX
Jan
31(1)Sales RevenueIncome SummaryTo close revenue account6000

6000
31(2)Income SummaryRent ExpenseSalary ExpenseOffice Supplies ExpenseUtilities ExpenseTo close expense accounts3320
 

14001200400320
 31(3)Income SummaryOwner, CapitalTo close net income to Capital 2680
 
 2680
 31(4)Owner, CapitalOwner, WithdrawalsTo close drawing account to Capital 1000 1000

Here is how the transactions above effect the Income Summary and Capital accounts. The number in parenthesis indicates which of the transactions results in the account’s entry:

Income Summary(2)  3320(3)  2680(1)  6000Owner’s Equity(4)  1000Bal   9000(3)  2680

When the revenue and expense accounts are closed to Income Summary and a credit balance exists, a net income is the result.  The opposite is true for a net loss; the Income Summary account has a debit balance. In the case of a net loss, the third entry above would contain a debit to Owner’s Capital and a credit to Income Summary.

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EIN Employer Identification Number

The Employer Identification Number (EIN – also known as Tax ID Number), is a nine-digit number issued to businesses by the IRS.  Obviously, a business that has employees needs an EIN, but there are instances when all business types and even individuals may need to get an EIN.

Who Needs an EIN

Keep in mind – EINs are not transferable, so if you buy or sell a business you or the new owner will need to get a new number.  The IRS PDF file Understanding your EIN explains all this in detail.

You need an EIN if:

• You have employees.

• Your business is operated as a Partnership or Corporation.

• You’re required to file Employment, Excise, or ATF Tax Returns

• You withhold taxes on income, other than wages, paid to a non-resident alien

• You have a Keogh Plan

• You’re involved in certain organizations such as trusts, estates, & farmer co-ops

How to Get Your Tax ID Number

To apply for an EIN taxpayers will need to use the IRS Form SS-4. You can apply for your EIN by mail, phone, fax, or online (you complete the form online).  It’ll take anywhere from a couple of hours to several weeks to get your number depending on which method you choose to apply.

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Accounting Examples – Trial Balance

Trial Balance

The Trial Balance, which can be taken at any point in time, lists all ledger accounts and their balances and is used to prove the equality of debits and credits. Assets are listed first followed by liabilities and then owner’s equity. Debit balances are listed in the left column and credit balances in the right column.

The trial balance proves that the accounts balance, but it does ensure that all transactions were entered or entered into the proper accounts. Below is an example of a Trial Balance.

Your Business NameTrial BalanceJune 31, 20XX
DebitCredit
Cash$800.00
Accounts Receivable400.00
Supplies600.00
Prepaid Rent1,200.00
Equipment10,000.00
Accounts Payable$3,000.00
Owner, Capital9,000.00
Owner, Drawing1,000.00
Sales3,000.00
Salary Expense700.00
Misc. Expense300.00
$15,000.00$15,000.00

A trial balance is an internal document used only by company employees; it is not meant to be available to persons outside the company.

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LLC – Limited Liability Company Example

LLC – Limited Liability Company
Limited Liability Company LLC Books

A Limited Liability Company (LLC) is sort of a cross between a partnership and a corporation.  A small business formed as an LLC affords its owners the advantages of limited liability (little or no personal liability like corporate shareholders have) along with pass-through taxation (a tax saving benefit enjoyed by partnerships and sole proprietorships).

Forming the LLC

Forming a LLC is a little more complicated than forming a partnership and less complicated than incorporating.  There are several steps that will need to be taken to make it all legal.  The company must be named, articles of organization need to be filed and fees paid, an LLC operating agreement must be created, and licenses and permits must be obtained where required.  The book Nolo’s Quick LLC: All You Need to Know About Limited Liability Companies explains forming an LLC in great detail.

LLC Taxation

Because a corporation is considered an entity separate from its owners, it is required to pay federal taxes.  An LLC is different. It’s more like a partnership or sole proprietorship in that; the profits and losses and associated tax responsibilities are divided up and passed through to the owners. Again, Nolo’s Quick LLC is recommended.

Other Things to Note

LLC owners are also known as members.  Single member LLCs are allowed in most states and there is no maximum number or type of members allowed.  An attorney is not required – you can prepare the documents and complete the requirements yourself.  Though not required by most States, an Operating Agreement is highly recommended.

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Owner Equity Accounts Examples

Owner Equity Accounts:

There are several types of transactions that effect owner equity including: investments, withdrawals of cash by the owner, revenue earned, and expenses incurred.  The accounts that collect data from these transactions are:

Capital Account – The companies net worth.  Initial and subsequent Investments are recorded here as well as changes in the equity of the owners; such as net income or loss. Capital stock represents the investment of stockholders for corporations, and retained earnings represents the net income/loss.

Drawing Account – Also known as the Personal Account, this account is used to record withdrawals from the company by the owner or owners.

Revenue Accounts – The gross increases to owner’s equity.  Sources include sales of merchandise or services, rental properties, lending money, commissions, and other income generating ventures.

Expense Accounts – The costs incurred during the day to day operation of the business are expenses.  Examples include, Salary Expense, Supplies Expense, Utilities Expense, and Rent Expense..

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Trial Balance Example

Trial Balance

The Trial Balance, which can be taken at any point in time, lists all ledger accounts and their balances and is used to prove the equality of debits and credits. Assets are listed first followed by liabilities and then owner’s equity. Debit balances are listed in the left column and credit balances in the right column.

The trial balance proves that the accounts balance, but it does ensure that all transactions were entered or entered into the proper accounts. Below is an example of a Trial Balance.

Your Business Name

Trial Balance

June 31, 20XX

Debit

Credit
Cash$800.00
Accounts Receivable400.00
Supplies600.00
Prepaid Rent1,200.00
Equipment10,000.00
Accounts Payable$3,000.00
Owner, Capital9,000.00
Owner, Drawing1,000.00
Sales3,000.00
Salary Expense700.00
Misc. Expense300.00
$15,000.00$15,000.00

 

A trial balance is an internal document used only by company employees; it is not meant to be available to persons outside the company.

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Chart of Accounts Example

Chart of Accounts:

The complexity of a company’s chart of accounts depends on a number of factors including: daily activity, type of business conducted, and to what detail records are needed for management decisions and tax authorities.  Some businesses have very few accounts, others have thousands.

It is common practice to assign a number to each account for indexing & coding transactions.  Although simply numbering the accounts sequentially will work, it is more advisable to use a flexible system as is depicted here.

Example Chart of Accounts

Balance Sheet Accounts

1. Assets

11. Cash

12. Accounts Receivable

14. Supplies

15. Prepaid Rent

18. Equipment

2. Liabilities

21. Accounts Payable

22. Salaries Payable

3. Owner’s Equity

31. Owner, Capital

32. Owner, Drawing

33. Income Summary

Income Statement Accounts

4. Revenue

41. Sales

42. Rental Property

5. Expenses

51. Supplies Expense

52. Salary Expense

53. Rent Expense

54. Misc. Expense

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Adjusting Entries Examples

End of Period Adjusting Entries

Before end-of-period financial reports are prepared, adjustments to prepaid and accrued accounts are made. This process helps provide a true indication of where the company stands financially and it matches income and expenses to the period they effect. There are several types of accounts that require adjustments:

  • Prepaid Expenses – items or services that are paid for up-front. They are classified as assets when purchased.
  • Unearned Revenues – revenues received before they are earned.  They are classified as liabilities when cash is received.
  • Accrued Revenues – revenues that have been earned but cash has not yet been received and no transaction has been recorded.
  • Accrued Expenses – expenses that have been incurred but not paid for yet and no transaction has been recorded.

Each of these adjustment types is described below along with examples and sample journal entries.

Prepaid Expenses

When an expense is prepaid (for example – prepayment of a 6-month insurance policy for $1,200) an asset is created. Think of it this way; the company is due something of value – the insurance coverage for a 6-month period in the future. To simply expense the $1,200 at the time cash is spent would inaccurately allocate the full amount to that period. Instead, accountants create a Prepaid Insurance account and subtract from it, each month, the amount that should be allocated to it ($1,200 ÷ 6 = $200). The first example entry below journalizes the prepayment of the 6-month policy; the second is the adjusting entry for the end of the first month.

 

General JournalPage: 1
Date

Account Titles/Explanation

Ref

Debit

Credit
20XX
Jan

1

Prepaid insurance

Cash

Paid insurance in advance

1200.00

1200.00

31

Insurance expense

Prepaid insurance

To record insurance expense.

200.00
200.00

After posting these transactions, the Prepaid Insurance account will have a balance of $1,000. At the end of each of the next 5 months an adjustment similar to the one above would be made. After the June 30th entry, the Prepaid Insurance account would have a zero balance and Insurance Expense would have a $1,200 balance.

Unearned Revenues

When revenue is received in advance (for example, receipt of a 6-month cleaning service fee of $600 up-front) a liability is created — the company owes something of value (cleaning services) to another. If the $600 were posted directly to revenue on the date it was received, it would incorrectly allocate the entire revenue to one month rather than spread it over 6 months, when it is actually earned. The example entries below record receipt of the fee (which creates the liability) and the adjustment at the end of the first month to record the revenue earned during January ($600 ÷ 6 = $100).

 

General JournalPage: 1
Date

Account Titles/Explanation

Ref

Debit

Credit
20XX
Jan

1

Cash

Unearned revenue

Received revenue in advance

600.00

600.00

31

Unearned revenue

Service revenue

To record revenue for services completed

100.00
100.00

At the end of each of the next 5 months, an adjustment similar to the one above would be made. After the June 30th entry, the revenue collected in advance would be correctly allocated to each of the months it was earned.

Accrued Revenues

When revenue has been earned but cash has not yet been received, accountants make an accrual adjusting entry. If an advertising company charges $1,500 for a month’s services payable at the end of 30 days and begins working in the middle of the month (i.e. Jan. 15 – Feb. 15), an entry must be made at the end of January to record the revenue earned during the period ($1,500 ÷ 2 = $750) as follows:

 

General JournalPage: 1
Date

Account Titles/Explanation

Ref

Debit

Credit
20XX
Jan

31

Accounts receivable

Service revenue

Paid insurance in advance

750.00

750.00

In February, when the customer makes payment of $1,500, Cash is debited $1,500, Accounts Receivable is credited $750 and Service Revenue is credited $750.

Accrued Expenses

Expenses are often incurred in one month or period and paid for in another.  Examples include interest, rent, and salaries. Consider an employee who is paid $2,400 on February 5th for the work he/she completed in January. In order to reflect the expense in the correct month, an adjustment must be made at the end January.

 

General JournalPage: 1
Date

Account Titles/Explanation

Ref

Debit

Credit
20XX
Jan

31

Salary expense

Salary payable

To accrue salary expense

2400.00

2400.00

On February 5th, when the employee is paid, Salary Payable is debited $2,400 and Cash is credited $2,400.

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Accounts Payable Example

Accounts Payable:

When goods, services, or supplies are purchased on account, they become, to the purchaser, an account payable (to the supplier, they are an account receivable). For example, if Your Company purchases office supplies and agrees to pay the supplier at a later date, the amount due from that purchase is recorded in your books as an account payable. The journal entry below illustrates how an on-account purchase of $200 in office supplies would be recorded:

General JournalPage: 1
Date

Account Titles/Explanation

Ref

Debit

Credit
20XX
Jan

5

Office Supplies

Accounts Payable

Bought office supplies on account.


200.00
200.00

When the account is paid, the following journal entry is made:

General JournalPage: 1
Date

Account Titles/Explanation

Ref

Debit

Credit
20XX
Jan

15

Accounts Payable

Cash

Paid on account.


200.00
200.00

Accounts Payable, like all asset and liability accounts, is a permanent account. That is, it is not closed at the end of the period as are income statement accounts; its balance carries over from one period to the next. The account is also a balance sheet account. This means that it appears on the balance sheet along with all the other asset, liability, and equity accounts. An example of a balance sheet containing accounts payable can be examined here.

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