Accounting Principles: Closing Entries

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Questions and Answers

What is the primary purpose of closing entries in accounting?

To record accrued expenses before they are paid

To prepare financial statements for external stakeholders

To transfer permanent account balances to temporary accounts

To reset temporary accounts to zero for the next accounting period (correct)

Which account is directly affected by closing entries?

Cash

Common Stock

Accounts Payable

Retained Earnings (correct)

If a business pays off a debt to a creditor, which accounts are affected?

Cash increases and Equity increases

Cash decreases and Liabilities increase

Cash increases and Assets decrease

Cash decreases and Liabilities decrease (correct)

What is recorded in an accrued expense adjusting entry?

Debit Expense, Credit Accounts Payable Signup and view all the answers

In which scenario does the accounting equation remain balanced?

When land is purchased and cash is also paid Signup and view all the answers

What must be done before recording adjusting journal entries at the end of the period?

Take inventory counts of assets and liabilities Signup and view all the answers

What happens to the Dividends account when dividends are paid?

It decreases equity Signup and view all the answers

Which of the following transactions directly increases equity?

Exchanging cash for stock Signup and view all the answers

Which equation correctly represents the basic accounting equation?

Assets = Liabilities + Equity Signup and view all the answers

What does a higher current ratio indicate about a company?

Better liquidity Signup and view all the answers

Which of the following best defines net income?

Revenues - Expenses Signup and view all the answers

Which financial statement reflects the changes in retained earnings over a period?

Statement of Retained Earnings Signup and view all the answers

What role do internal users of accounting information typically play?

Making decisions to improve business operations Signup and view all the answers

What step is involved in preparing the unadjusted trial balance?

Recording all transactions during a period Signup and view all the answers

What is the primary purpose of managerial accounting?

To aid managerial decision-making Signup and view all the answers

What does working capital measure?

Current assets minus current liabilities Signup and view all the answers

Study Notes

Closing Entries

Closing entries are made at the end of an accounting period.
They reset temporary accounts such as revenue, expense, and dividends to zero.
This prepares them for the next accounting period.
Closing entries are used to transfer the balance from temporary accounts into Retained Earnings.
Retained Earnings is a permanent account recording a company’s overall equity.

Transactions Impacting the Accounting Equation

The accounting equation states: Assets = Liabilities + Equity.
Every business transaction will affect at least one of these categories.
The accounting equation must always remain balanced.
Example transactions:
- Paying a creditor: Decreases both cash (asset) and Liabilities.
- Purchasing Land: Increases Land (asset) and decreases Cash (asset).
- Receiving cash from a credit customer: Increases Cash (asset) and decreases Accounts Receivable (asset).
- Exchanging cash for stock to start a business: Increases Cash (asset) and Equity.
Key takeaway: Each transaction must impact the equation while keeping it balanced.

Adjusting Journal Entries

Adjusting entries are made at the end of an accounting period to ensure up-to-date financial information.
They account for events that have occurred but haven’t been formally recorded yet.
They are categorized as accruals or deferrals.
Accruals:
- Accrued revenue: Revenue earned but not yet collected.
- Debits Accounts Receivable and credits revenue.
- Accrued expenses: Expenses incurred but not yet paid.
- Debits expense and credits Accounts Payable.

Journal Entry Transactions

Examples:
- Paying a creditor on account: Debits Accounts Payable, credits Cash.
- Purchasing land: Debits Land, credits Cash.
- Receiving cash from a credit customer: Debits Cash, credits Accounts Receivable.
- Starting a business by exchanging cash for stock: Debits Cash, credits Common Stock.
- Paying dividends: Debits Dividends, credits Cash.

Calculations

Important formulas and concepts:
- Balance Sheet (Accounting Equation): Assets = Liabilities + Equity.
- Income Statement: Net Income = Revenues – Expenses.
- Statement of Retained Earnings: Ending Retained Earnings = Beginning Retained Earnings + Net Income – Dividends.
- Working Capital: Working Capital = Current Assets – Current Liabilities.
- Current Ratio: Current Ratio = Current Assets / Current Liabilities.
- A higher current ratio indicates better liquidity.

Ethics

Ethical behavior in accounting involves:
- Providing accurate and honest financial information.
- Following established rules and laws.
- Acting in the best interest of all stakeholders (employees, investors, customers, etc.).

Accounting Information Users

Internal Users: Managers and employees make decisions using accounting information.
External Users: Investors, creditors, and government agencies utilize financial statements to assess financial health.

Accounting Importance

Provides information essential for business decisions, performance tracking, and ensuring transparency.

Managerial vs. Financial Accounting

Managerial Accounting: Provides information for internal users (managers) to aid in decision-making and company operations.
Financial Accounting: Provides information for external users (investors, creditors) through financial statements adhering to regulations.

The Accounting Cycle

Major Stages:
- Three sets of trial balances:
  - Unadjusted Trial Balance: Prepared after recording transactions but before adjustments.
  - Adjusted Trial Balance: Prepared after adjusting journal entries (accruals, deferrals) have been made.
  - Post-Closing Trial Balance: Prepared after closing entries (revenues, expenses, dividends closed to Retained Earnings) have been made.

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Description

This quiz covers the concept of closing entries in accounting, which are essential at the end of an accounting period. It explains how these entries reset temporary accounts and transfer balances to Retained Earnings. Additionally, it reviews transactions that impact the accounting equation, ensuring the fundamental balance of Assets, Liabilities, and Equity is maintained.