Chapter 5
Questions
Real/permanent accounts are those that carry over from one period to the next, with a continuing balance in the account. Examples are asset accounts, liability accounts, and equity accounts. In contrast, revenue accounts, expense accounts, and dividend accounts are not real/permanent accounts.
Closing entries are used to transfer the contents of the temporary accounts into the permanent account, Retained Earnings, which resets the temporary balances to zero, enabling tracking of revenues, expenses, and dividends in the next period.
Expense accounts and dividend accounts are credited during closing. This is because closing requires that the account balances be cleared, to prepare for the next accounting period.
Income Summary is a super-temporary account that is only used for closing. The revenue accounts are closed by a debit to each account and a corresponding credit to Income Summary. Then the expense accounts are closed by a credit to each account and a corresponding debit to Income Summary. Finally, the balance in Income Summary is cleared by an entry that transfers its balance to Retained Earnings. Thus, it is used in three journal entries, as part of the closing process, and has no other purpose in the accounting records.
The fact that Income Summary has a credit balance (of any size) after the first two closing entries are made indicates that the company made a net profit for the period. In this case, a credit of $125,500 reflects the fact that the company earned net income of $125,500 for the period.
The post-closing trial balance will include only the permanent/real accounts, which are assets, liabilities, and equity. All of the other accounts (temporary/nominal accounts: revenue, expense, dividend) would have been cleared to zero by the closing entries.
Working capital is calculated by subtracting current liabilities from current assets. The result indicates how well the company can pay bills as they come due, which is sometimes referred to as the company’s liquidity position.
(1) First is the Unadjusted Trial Balance, which summarizes the account balances of all accounts in the ledger, before period-end adjustments. (2) Next, the Adjusted Trial Balance summarizes the account balances of all accounts in the ledger, after adjusting entries have been posted. (3) Finally, the Post-Closing Trial Balance summarizes the account balances of all accounts in the ledger, after closing entries have been posted.