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Closing Entries - Financial Accounting

  1. After posting adjusting entries, a company's accountant calculates that net income is $120,000. However, the accountant then discovers that a $15,000 rent expense for the year was mistakenly debited to Prepaid Rent. This error has not yet been corrected. What amount should be credited to Retained Earnings when closing the Income Summary account, assuming the correction is made before closing?
    Answer: $105,000 First, the effect of the error on the initial net income calculation must be determined. The company failed to record a $15,000 rent expense, which means expenses were understated and net income was overstated by $15,000. The correct net income is the calculated amount ($120,000) minus the omitted expense ($15,000), which equals $105,000. A correcting entry would be made (Debit Rent Expense, Credit Prepaid Rent), and then the closing entries would proceed based on the corrected balances. The amount of net income to be closed from Income Summary to Retained Earnings is this corrected figure, $105,000. This is accomplished with a credit to Retained Earnings.
  2. What is the net effect on Retained Earnings from the closing entry, and what will be the ending Retained Earnings balance?
    Answer: Net increase of $59,700; ending balance of $144,700 The closing entry transfers all temporary accounts to Retained Earnings. Revenues increase RE: $145,000 + $3,200 = $148,200. Expenses and dividends decrease RE: $18,000 + $62,000 + $8,500 + $12,000 = $100,500. Net effect = $148,200 - $100,500 = $59,700 increase. Ending RE = $85,000 + $59,700 = $144,700. Choice B incorrectly excludes dividends from the closing calculation. Choice C incorrectly omits Interest Revenue. Choice D incorrectly excludes Depreciation Expense.
  3. A company's year-end adjusted trial balance showed Service Revenue of $400,000, Salaries Expense of $220,000, and Rent Expense of $80,000. In the post-closing trial balance, the Retained Earnings account had a credit balance of $150,000. No dividends were paid during the year. What was the beginning-of-year balance of Retained Earnings?
    Answer: $50,000 This problem requires working backward. First, calculate the net income for the year: Service Revenue ($400,000) - Salaries Expense ($220,000) - Rent Expense ($80,000) = $100,000. Second, use the Retained Earnings formula: Ending RE = Beginning RE + Net Income - Dividends. Plugging in the known values: $150,000 (Ending RE) = Beginning RE + $100,000 (Net Income) - $0 (Dividends). Solving for Beginning RE gives $150,000 - $100,000 = $50,000.
  4. A sole proprietorship's adjusted trial balance includes the following: Service Revenue, $90,000; Operating Expenses, $55,000; and Owner's Drawings, $12,000. The owner's capital account has a beginning balance of $75,000. What is the total credit to the owner's capital account during the closing process?
    Answer: $35,000 In a sole proprietorship, temporary accounts are closed to the owner's capital account. The closing process involves crediting the capital account for the amount of net income and debiting it for the amount of owner's drawings. First, calculate net income: Revenue ($90,000) – Expenses ($55,000) = $35,000. This net income is closed to the capital account with a credit of $35,000. The owner's drawings are closed with a separate debit to the capital account. The question asks for the total credit to the capital account during closing, which is solely the amount of net income. The net change would be $35,000 - $12,000 = $23,000, but the question specifically asks for the credit.
  5. Phoenix Manufacturing uses the Income Summary method for closing entries. After closing revenues and expenses, the Income Summary account has a debit balance of $18,000. Before any closing entries, Retained Earnings had a credit balance of $275,000 and Dividends had a debit balance of $22,000. What will be Retained Earnings' final balance after all closing entries are complete?
    Answer: Credit balance of $235,000 reflecting the net loss and dividend distributions for the period The closing entries process involves transferring temporary account balances to retained earnings through the Income Summary account. When Income Summary has a debit balance after closing revenues and expenses, this indicates the company had a net loss for the period. Here's how to calculate the final retained earnings balance step by step. Start with the beginning retained earnings credit balance of $275,000. The Income Summary debit balance of $18,000 represents a net loss, which reduces retained earnings by $18,000. Then close the Dividends account, which has a debit balance of $22,000, further reducing retained earnings. The calculation is: $275,000 - $18,000 - $22,000 = $235,000. Answer A ($315,000) incorrectly treats the Income Summary debit balance as income rather than a loss, adding $18,000 instead of subtracting it. This fundamental error leads to an inflated retained earnings balance. Answer B ($257,000) correctly handles the net loss by subtracting $18,000 but fails to account for the dividend distribution, stopping the closing process prematurely. Answer D ($279,000) makes a calculation error by only subtracting $18,000 and adding back $22,000, suggesting confusion about how dividends affect retained earnings. Remember this pattern: when Income Summary has a debit balance, you're dealing with a net loss that reduces retained earnings. Always complete all closing entries—both the Income Summary and Dividends accounts must be closed to retained earnings. A systematic approach prevents the calculation errors that make wrong answers tempting.
  6. Which of the following accounts would have a non-zero balance on a company's post-closing trial balance?
    Answer: Unearned Revenue The purpose of closing entries is to reduce the balances of all temporary (or nominal) accounts to zero. Temporary accounts include all revenue accounts, expense accounts, and the dividends account. Permanent (or real) accounts are not closed and carry their balances forward to the next period. Unearned Revenue is a liability account, which is a permanent account. Therefore, it will have a non-zero balance on the post-closing trial balance. Depreciation Expense, Dividends, and Service Revenue are all temporary accounts that will be closed to Retained Earnings and thus have zero balances after the closing process.
  7. If a company fails to make the closing entry for its expense accounts at year-end, what is the resulting impact on the financial statements for that year?
    Answer: Ending retained earnings on the balance sheet will be overstated. Closing entries zero out temporary accounts and transfer the net effect to Retained Earnings. If expense accounts are not closed, their debit balances are not transferred to Income Summary (and subsequently to Retained Earnings). This means the reduction in Retained Earnings that should result from expenses is omitted. Therefore, Retained Earnings, and by extension total equity, will be overstated on the year-end balance sheet. The post-closing trial balance would still balance, but the balances for Retained Earnings and the expense accounts would be incorrect. Net income is calculated before closing entries, so it would be reported correctly on the income statement. Closing entries do not affect liabilities.
  8. Using the four-step closing process with Income Summary, what will be the balance in Income Summary immediately before it is closed to Retained Earnings?
    Answer: Credit balance of $83,000 representing net income before considering dividend distributions to shareholders The four-step closing process transfers temporary account balances to Retained Earnings through Income Summary. When you encounter closing entries, focus on identifying which accounts actually affect net income versus those that represent distributions of earnings. To find the Income Summary balance before closing to Retained Earnings, you need to calculate net income by combining all revenue and expense accounts. Start with revenues: Sales Revenue $380,000 + Interest Revenue $8,000 = $388,000 total revenues. Next, sum all expenses and losses: Rent Expense $45,000 + Salaries Expense $195,000 + Utilities Expense $18,000 + Depreciation Expense $32,000 + Loss on Equipment Disposal $15,000 = $305,000 total expenses. Net income equals $388,000 - $305,000 = $83,000 credit balance in Income Summary. The key insight is that Stock Dividends Distributed should not affect this calculation. While the passage mentions Atlantic's policy of closing dividends through the same process, dividends represent distributions of earnings to shareholders, not income statement items that determine net income. Choice A incorrectly includes dividends as favorable to income, which contradicts basic accounting principles. Choice C erroneously reduces income by the dividend amount ($83,000 - $25,000 = $58,000), treating dividends as expenses rather than distributions. Choice D suggests a net loss, which contradicts the calculated $83,000 net income. Remember that Income Summary reflects net income before any dividend considerations. Dividends never appear on the income statement—they're equity transactions that reduce retained earnings directly, separate from the income determination process.
  9. Which of the following describes the net effect on total stockholders' equity when a company closes its $200,000 of revenue accounts and $130,000 of expense accounts using the Income Summary account?
    Answer: No net effect. Closing entries are classification entries made entirely within the stockholders' equity section of the balance sheet. Revenue, expense, and income summary accounts are all temporary equity accounts. When revenues (which increase equity) are closed, the balance is moved from the Revenue account to the Income Summary account. When expenses (which decrease equity) are closed, the balance is moved from the Expense accounts to the Income Summary account. The net effect of these specific steps on total stockholders' equity is zero because the amounts are simply being moved between different temporary equity accounts. The final step of closing Income Summary to Retained Earnings also has no net effect on total equity, as it moves a balance from one equity account (Income Summary) to another (Retained Earnings).
  10. Sunset Corporation's bookkeeper made an error in the closing entries by debiting Income Summary for $45,000 and crediting Consulting Revenue for $45,000, intending to close revenue to Income Summary. What is the net effect of this error on the Income Summary balance, and what correcting entry is needed?
    Answer: Income Summary is understated by $90,000; correcting entry should debit Consulting Revenue $90,000 and credit Income Summary $90,000 When you encounter closing entry errors, you need to analyze both what should have happened versus what actually happened to determine the net impact. In proper closing entries, revenue accounts should be debited to bring them to zero, with Income Summary credited. The correct entry should have been: debit Consulting Revenue $45,000, credit Income Summary $45,000. This would increase Income Summary by $45,000 (the normal result when closing revenue). However, the bookkeeper did the opposite: debit Income Summary $45,000, credit Consulting Revenue $45,000. This decreased Income Summary by $45,000 instead of increasing it. The net effect is that Income Summary is $90,000 lower than it should be ($45,000 it should have gained minus the $45,000 it actually lost). Therefore, Income Summary is understated by $90,000, and the correcting entry must debit Consulting Revenue $90,000 and credit Income Summary $90,000. Looking at the wrong answers: Choice A only recognizes half the error by assuming Income Summary just missed the $45,000 credit, ignoring that it was incorrectly debited. Choice C incorrectly states Income Summary is overstated when it's actually understated. Choice D wrongly suggests Income Summary shows the correct balance, which ignores the $45,000 debit that reduced it below the proper amount. Study tip: For closing entry error questions, always trace through both the correct entry and the actual entry, then calculate the difference between where the account should be versus where it actually is. The correction must bridge that full gap.
  11. The adjusted trial balance of a company shows a credit balance of $25,000 in the Income Summary account after closing all revenue and expense accounts. The trial balance also shows a $5,000 debit balance in the Dividends account. What is the net effect of the remaining closing entries on the Retained Earnings account?
    Answer: A net credit of $20,000. There are two remaining closing entries. First, the Income Summary account must be closed to Retained Earnings. Since Income Summary has a $25,000 credit balance (representing net income), the entry is a debit to Income Summary for $25,000 and a credit to Retained Earnings for $25,000. Second, the Dividends account must be closed to Retained Earnings. This entry is a debit to Retained Earnings for $5,000 and a credit to Dividends for $5,000. The net effect on Retained Earnings is a $25,000 credit and a $5,000 debit, resulting in a net credit (increase) of $20,000.
  12. A company experienced a net loss of $40,000 for the year. The company also declared and paid dividends of $10,000. The beginning balance in Retained Earnings was $150,000. Which of the following represents the journal entry to close the Income Summary account?
    Answer: Debit Retained Earnings $40,000; Credit Income Summary $40,000. A net loss means that total expenses exceeded total revenues. This results in the Income Summary account having a debit balance. To close an account with a debit balance, it must be credited. The corresponding debit is to Retained Earnings, which reduces the account's balance. Therefore, the correct entry is to debit Retained Earnings for $40,000 and credit Income Summary for $40,000. The closing of dividends is a separate entry (Debit Retained Earnings $10,000, Credit Dividends $10,000) and is not combined with closing the Income Summary account.
  13. The closing process for a business with a net loss involves which of the following entries?
    Answer: A debit to Retained Earnings and a credit to Income Summary. A net loss occurs when total expenses exceed total revenues. After closing revenues (credit to Income Summary) and expenses (debit to Income Summary), the Income Summary account will have a net debit balance. To close this account, it must be credited. The corresponding debit is made to Retained Earnings, reflecting the decrease in equity due to the loss. Therefore, the entry to close Income Summary in a net loss situation is a debit to Retained Earnings and a credit to Income Summary.
  14. When preparing closing entries, what is the net amount that should be closed from revenue-related accounts to Income Summary?
    Answer: Credit Income Summary for $430,000 representing gross sales less all contra-revenue items When preparing closing entries, you need to understand that revenue-related accounts include gross sales and any contra-revenue accounts that directly reduce sales. The goal is to determine the net revenue amount that flows to Income Summary. Start with Gross Sales of $450,000, then subtract the contra-revenue accounts: Sales Returns and Allowances ($12,000) and Sales Discounts ($8,000). This gives you: 450,000−12,000−8,000=430,000450,000 - 12,000 - 8,000 = 430,000. This net sales amount of $430,000 should be credited to Income Summary when closing revenue-related accounts. Answer A incorrectly includes Purchase Discounts in the revenue calculation. Purchase Discounts ($6,000) is a contra-expense account that reduces Cost of Goods Sold, not a revenue item. Including it would artificially inflate the revenue closure amount. Answer B makes the same error as A by including Purchase Discounts, calling it a "beneficial effect on revenue." While purchase discounts do benefit the company, they affect expense accounts, not revenue accounts during closing entries. Answer C suggests closing gross sales separately from contra-revenue accounts. This approach is unnecessarily complicated and doesn't reflect the standard practice of closing net amounts to Income Summary. Answer D correctly identifies that only gross sales less contra-revenue items should be closed to Income Summary, yielding $430,000. Study tip: Remember that closing entries should group related accounts logically. Revenue accounts (including contra-revenue) close together, expense accounts (including contra-expense) close together. Don't mix purchase-related accounts with sales-related accounts during the closing process.
  15. An adjusted trial balance has total debits of $250,000. The trial balance includes the following permanent account balances: Cash $30,000; Accounts Receivable $40,000; Equipment $100,000; Accumulated Depreciation $20,000; Accounts Payable $15,000; Common Stock $80,000; and beginning Retained Earnings $35,000. The Dividends account has a balance of $5,000. What is the ending balance of Retained Earnings after closing entries?
    Answer: $55,000 This is a multi-step problem. First, determine total revenues and total expenses by analyzing the trial balance totals. 1. Total credits are $250,000. Find the sum of permanent credit accounts: Acc. Dep. ($20k) + A/P ($15k) + CS ($80k) + Beg. RE ($35k) = $150,000. The remaining credit balance must be from temporary accounts (revenues). So, Total Revenues = $250,000 - $150,000 = $100,000. 2. Total debits are $250,000. Find the sum of permanent debit accounts: Cash ($30k) + A/R ($40k) + Equip. ($100k) = $170,000. The remaining debit balance must be from temporary accounts (expenses and dividends). So, Expenses + Dividends = $250,000 - $170,000 = $80,000. 3. Since Dividends are $5,000, Total Expenses = $80,000 - $5,000 = $75,000. 4. Calculate Net Income: Revenues ($100k) - Expenses ($75k) = $25,000. 5. Calculate Ending Retained Earnings: Beg. RE ($35k) + Net Income ($25k) - Dividends ($5k) = $55,000.
  16. A company uses a single, compound journal entry to close all its temporary accounts directly to Retained Earnings, bypassing the Income Summary account. The company has Service Revenue of $150,000, Salaries Expense of $80,000, Rent Expense of $20,000, and Dividends of $10,000. Which of the following correctly describes a part of the required compound entry?
    Answer: A credit to Retained Earnings for $40,000. When bypassing Income Summary, revenues are debited, expenses are credited, and the net difference (net income) is credited to Retained Earnings. A separate entry is still typically made for dividends. The first entry would be: Debit Service Revenue $150,000; Credit Salaries Expense $80,000; Credit Rent Expense $20,000; Credit Retained Earnings $50,000. The second entry closes dividends: Debit Retained Earnings $10,000; Credit Dividends $10,000. The question asks for a part of the required compound entry. Often, these are combined. If combined, the entry would be: Debit Service Revenue $150,000 Credit Salaries Expense $80,000 Credit Rent Expense $20,000 Credit Dividends $10,000 Credit Retained Earnings $40,000 This single entry closes all accounts and updates retained earnings. A credit to Retained Earnings for $40,000 is part of this entry. A credit of $50,000 would be correct if dividends were closed separately. A debit to RE for $110k is incorrect. A credit to Dividends is part of the entry, but the question is more likely testing the net effect on RE.
  17. The ending Retained Earnings balance of a corporation was $250,000. During the year, the corporation reported net income of $80,000 and paid dividends. The beginning Retained Earnings balance was $200,000. What journal entry was made to close the Dividends account at year-end?
    Answer: Debit Retained Earnings $30,000; Credit Dividends $30,000. This question requires working backwards to find the amount of dividends paid. The formula for ending Retained Earnings is: Ending RE = Beginning RE + Net Income - Dividends. We can solve for Dividends: $250,000 = $200,000 + $80,000 - Dividends. This gives $250,000 = $280,000 - Dividends, so Dividends = $30,000. The closing entry for the Dividends account involves transferring its debit balance to Retained Earnings. This is accomplished by debiting Retained Earnings and crediting the Dividends account to zero it out. Therefore, the entry is Debit Retained Earnings $30,000 and Credit Dividends $30,000.
  18. During the year-end closing process, an accountant correctly closed all revenue and expense accounts to Income Summary, resulting in a $95,000 credit balance. The accountant then made the following erroneous entry: Debit Retained Earnings $95,000, Credit Income Summary $95,000. Dividends of $20,000 were closed correctly. How will this error affect the final balance of Retained Earnings?
    Answer: Retained Earnings will be understated by $190,000. A $95,000 credit balance in Income Summary represents net income. The correct closing entry is to debit Income Summary and credit Retained Earnings, increasing the RE balance by $95,000. The accountant made the opposite entry: debiting RE and crediting Income Summary. This incorrect entry decreased Retained Earnings by $95,000. The net effect is the difference between what should have happened (+95,000) and what did happen (-95,000), which is a total understatement of $190,000. The correct closing of dividends does not affect this particular error.
  19. After completing steps 1 and 2 of the closing process, what should be the balance in the Income Summary account before step 3?
    Answer: Credit balance of $39,000 representing net income for the period After steps 1-2: Revenues closed = $280,000 + $15,000 = $295,000 (credit to Income Summary). Expenses closed = $168,000 + $75,000 + $13,000 = $256,000 (debit to Income Summary). Net balance = $295,000 - $256,000 = $39,000 credit, representing net income. Choice B incorrectly includes dividends, which close separately in step 4. Choice C shows only the debit side. Choice D incorrectly suggests additional tax adjustments to the closing process.
  20. A company is performing its year-end closing process. The accountant makes the following journal entry: Debit: Income Summary $75,000 Credit: Retained Earnings $75,000 Which of the following statements accurately describes the event this entry represents?
    Answer: The company earned a net income of $75,000, which increases retained earnings. This entry closes the Income Summary account to Retained Earnings. Income Summary has a credit balance when revenues exceed expenses (net income) and a debit balance when expenses exceed revenues (net loss). To close a credit balance in Income Summary, it must be debited. The corresponding credit to Retained Earnings increases total equity. Therefore, this entry reflects the closing of a $75,000 net income to Retained Earnings. Distractor B describes the entry for a net loss, which would be a debit to Retained Earnings and a credit to Income Summary. Distractor C is incorrect because revenues are closed to Income Summary with a credit, not from Income Summary to Retained Earnings. Distractor D is incorrect because dividends are closed directly to Retained Earnings with a debit to Retained Earnings.

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