Lesson 10.

6
Accounting Cycle for
Merchandising-Type
Businesses: Closing

Fundamentals of Accountancy, Business,

and Management 1
Accountancy, Business, and Management

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Every beginning always
has an ending. That is
why a merchandising
business's last cycle is
the preparation of
closing entries before
the start of another fiscal
year.
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From here,
merchandising
businesses may make
an economic decision
and see the bigger
picture of how the
business performs.
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Quick Look
Blue Clothing Line
You have been an accountant for Blue Clothing for a
year now. The business provides smart casual clothing
for kids and teenagers and has been operating for
several years. Despite being in the industry for several
years, Blue Clothing does not have the resources for
accounting software due to its budget limitations. As
the business's accountant, it means that you must
prepare all steps in the accounting cycle manually.
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Quick Look
Blue Clothing Line
It is the end of the month, and you have prepared
a post-closing trial balance. Before submitting the
report, you noticed that revenue accounts are still
listed in the trial balance. This situation leaves you
with the task of making a sound decision on what
to do with this kind of error before submitting the
report to your supervisor.
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Quick Look Questions to Ponder

1. Why is it an error to have revenue accounts

on the post-closing trial balance?
2. What should you do to fix this error?
3. What would be the outcome if you
disregarded the error and proceeded with
reporting the financial data?

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Learning Competency

Complete the accounting cycle of a merchandising business

(ABM_FABM11-IVe-j-40).

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Learning Objectives

At the end of this lesson, you should be

able to do the following:
● Define closing entries.
● Identify the purpose of closing entries.
● Prepare a post-closing trial balance.

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 ● A journal entry
prepared at the end

Closing
of an accounting
period
Represents the

Entry
●
transfer of balances
from a temporary
account to a
permanent account
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 Merchandising
businesses use
Closing closing entries to
reset the
Entry balances of
temporary
accounts.
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 Definition and Purpose of Closing Entries

Temporary Accounts Income Summary

comprise income used to transfer the
balances of temporary
statement
accounts to a business's
accounts, such as capital account, which is
sales and expense a permanent account on
the balance sheet
accounts.
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Closing Temporary or Nominal Accounts

Made at the end of

an accounting
Closing journal period to prepare
entries temporary
accounts for the
next period
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 Steps in Closing Temporary or Nominal Accounts

In accounting, we often
refer to the process of
closing as closing the
books. The four basic steps
in the closing process are:
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 Steps in Closing Temporary or Nominal Accounts

Sales - Revenue earned from rendering services.

Purchase Returns and Allowances - Are deductions from purchases for items
returned to suppliers or discounts received for goods already recorded in the accounts.
Purchase Discount - Is an offer from the supplier to the purchaser, to reduce the
payment amount if the payment is made within a certain period of time.
Income Summary - Is not reported on any financial statements because it is only
used during the closing process, and at the end of the closing process the account
balance is zero.

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 Steps in Closing Temporary or Nominal Accounts

Step 1: Close revenue accounts to income

summary.
In this step, you debit sales, purchase returns and allowances,
purchase discounts, and credit the income summary.

Closing the revenue accounts: transferring the credit balances

in the revenue accounts to a clearing account called Income
Summary.

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 Steps in Closing Temporary or Nominal Accounts

Step 1: Close revenue accounts to income

summary.

Sales xxx
Purchase Returns and Allowances xxx
Purchase Discount xxx
Income Summary xxx
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 Steps in Closing Temporary or Nominal Accounts

Step 2: Close expense and contra-revenue

accounts to income summary.
In this step, you debit the income summary and
credit expenses and contra-revenues accounts.

Closing the expense accounts: transferring the

debit balances in the expense accounts to a
clearing account called Income Summary.
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 Steps in Closing Temporary or Nominal Accounts

Step 2: Close expense and contra-revenue

accounts to income summary.
A contra revenue account is a type of revenue account
that has a debit balance instead of the usual credit
balance. It is used to record transactions that reduce the
gross amount of a company’s revenue. Two examples of
contra revenue accounts are Sales Returns and
Allowances and Sales Discounts
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 Steps in Closing Temporary or Nominal Accounts

Purchases in accounting refers to the taking control of a given item or service by paying a
set amount of money.
Sales returns and allowances are refunds or credits given to customers for returned
products or products that they are allowed to keep without full payment. Sales returns and
allowances are deducted from sales revenue when net sales are calculated.
Sales discount is an incentive the seller offers in exchange for prompt payment on credit
sales.
Cost of goods sold (COGS) includes all of the costs and expenses directly related to the
production of goods.
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 Steps in Closing Temporary or Nominal Accounts

Step 2: Close expense and contra-revenue

accounts to income summary.
Income Summary xxx
Purchases xxx
Sales Returns and Allowances xxx
Sales Discount xxx
Cost of goods sold xxx
Expenses xxx

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 Steps in Closing Temporary or Nominal Accounts

For instance, if a company sells P100,000 worth of merchandise on

account, it will debit Accounts Receivable for P100,000 and credit
to Sales for P100,000.
If a customer returns P500 of this merchandise, the company will
debit Sales Returns and Allowances for P500 and will
credit Accounts Receivable for P500.
The company’s income statement will report the gross sales of
P100,000 minus the sales returns and allowances of P500 and the
resulting net sales of P99,500.
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 Steps in Closing Temporary or Nominal Accounts

Step 3: Close income summary account to

owner’s capital.
In this step, you debit the income summary and credit
the capital account or vice versa, depending on whether
there is a net income or net loss.

Closing the Income Summary account: transferring the

balance of the Income Summary account to the owner’s
capital account.
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 Steps in Closing Temporary or Nominal Accounts

Step 3: Close income summary account to

owner’s capital.
● If the balance in the Income Summary before closing is
a credit balance (company has a net income), you will
debit Income Summary and credit Capital.
● If the balance in the Income Summary before closing is
a debit balance (company has a net loss), you will credit
Income Summary and debit Capital.

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 Steps in Closing Temporary or Nominal Accounts

Step 3: Close income summary account to

owner’s capital.
To close the income summary when the company has a net
income:

Income Summary xxx

Owner’s Capital xxx

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 Steps in Closing Temporary or Nominal Accounts

Step 3: Close income summary account to

owner’s capital.
To close the income summary when the company has a net
loss:

Owner’s Capital xxx

Income Summary xxx

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 Steps in Closing Temporary or Nominal Accounts

Step 4: Close the drawing account to the

owner's capital.
In this step, you debit the owner's capital
account and credit the owner's drawing account.
Closing the withdrawal account: transferring the
debit balance of the owner withdrawal account
to the capital account.
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 Steps in Closing Temporary or Nominal Accounts

Step 4: Close the drawing account to the

owner's capital.

Owner’s Capital xxx

Owner’s Drawing xxx

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 Dream Athletics Co.

Dream Athletics Co. is a sports apparel

shop that provides different clothing types
that are strategically designed for a
specific sport. Below is the Adjusted Trial
Balance of the business for the year one of
its operations.
Dream Athletics Co. Unadjusted Trial Balance
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 Dream Athletics Co.

Step 1: Close revenue accounts to income summary.

Sales 30,000

Income Summary 30,000

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 Dream Athletics Co.

Step 2: Close expense accounts to income summary.

Income Summary 129,000

Purchases 50,000

Utilities Expense 14,000

Salaries Expense 65,000

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 Dream Athletics Co.

Step 3: Close income summary to owner’s capital.

Income Summary
129,000 30,000

99,000

Dream, Capital 99,000

Income Summary 99,000
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 Dream Athletics Co.

Step 4: Close the drawing account to the capital account.

Dream, Capital 48,000

Dream, Drawings 48,000

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 Check Your Progress

What will be the outcome if a business chooses not to close

1 its temporary accounts before starting a new accounting
period?

Answer area

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 Preparation of Post-Closing Trial Balance

● List all balance sheet accounts that

contain non-zero balances at the end of
an accounting period.
● Used to ascertain that the total of all
debit balances equals the total of all
credit balances.
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Preparation of Post-Closing Trial Balance

(Name of Business)
Post-Closing Trial Balance
December XX, 202x

Accounts Debit Credit

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 Preparation of Post-Closing Trial Balance

Using the financial data of Dream Athletics Co., get the ending
capital account of the business.

Dream, Capital
48,000 1,500,000
99,000
1,353,000

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 Preparation of Post-Closing Trial Balance

Dream Athletics Co.

Unadjusted Trial Balance
December 31, 202x
Account Title Debit Credit
Cash 1,300,500
Accounts Receivable 30,000
Supplies 6,500
Equipment 15,000
Furniture and Fixtures 15,000
Prepaid Insurance 12,000
Accounts Payable 6,000
Unearned Revenue 20,000
Dream, Capital 1,353,000
1,379,000
___________ 1,379,000
___________

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Keep in Mind

● Closing entries prepare a company for the next accounting period by

zeroing out any outstanding balances in accounts that should not be
transferred over to the next accounting period.

● Temporary accounts (revenues and expenses), used to prepare the

income statement at the end of the accounting period, should be
closed to the income summary account.

● The income summary is used to transfer the balances of temporary

accounts to a business's capital account.

● A post-closing trial balance records all balance sheet accounts that

contain non-zero balances at the end of an accounting period.
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Keep in Mind

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Photo Credit

Slide 1: Business Calculation Finance, by mohamed_hassan is free to use under the Pixabay License via Pixabay.

Slide 3: Detective Male Adult, by mohamed_hassan is free to use under the Pixabay License via Pixabay.

Slide 4: Accountant Calculator Accounting , by mohamed_hassan is free to use under the Pixabay License via Pixabay.

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Bibliography

Boyd, Ken, et al. Accounting for Dummies: All in One. NJ: John Wiley & Sons, Inc, 2014.

Gilbertson, Claudia and Mark Lehman. Century 21 Accounting. Ohio: South-Western Cengage Learning, 2008.

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