10.2 Why are ledgers closed?
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Revenue and expense accounts are closed at the end of each reporting period by resetting their balances to zero. This allows the firm to 1) determine its net profit for the period, 2) reset balances so net profit can be calculated for the next period, and 3) complete the accounting cycle and prepare required financial reports. Closing is necessary to comply with accounting principles such as the reporting period principle and relevance, which require separating transactions and financial results into discrete accounting periods.
![© Michael Allison, Trinity Grammar School.
Author’s permission required for external use
Why are Revenue and Expense accounts closed at the end of each
reporting period? Because it allows the firm to:
10.2 WHY ARE LEDGERS CLOSED?
1. Determine its Net Profit for
this period
2. Reset balances to zero so Net
Profit for next period can be
determined.
Sales [R]
30/6 Cash at Bank 35000
30/6 53000 30/6 Debtors Cont. 18000
53000 53000
Sales [R]
30/6 Cash at Bank 35000
30/6 53000 30/6 Debtors Cont. 18000
53000 53000](data:image/gif;base64,R0lGODlhAQABAIAAAAAAAP///yH5BAEAAAAALAAAAAABAAEAAAIBRAA7)
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10.2 Why are ledgers closed?
- 2. © Michael Allison, Trinity Grammar School. Author’s permission required for external use Why are Revenue and Expense accounts closed at the end of each reporting period? Because it allows the firm to: 10.2 WHY ARE LEDGERS CLOSED? 1. Determine its Net Profit for this period 2. Reset balances to zero so Net Profit for next period can be determined. Sales [R] 30/6 Cash at Bank 35000 30/6 53000 30/6 Debtors Cont. 18000 53000 53000 Sales [R] 30/6 Cash at Bank 35000 30/6 53000 30/6 Debtors Cont. 18000 53000 53000
- 3. © Michael Allison, Trinity Grammar School. Author’s permission required for external use Balance Sheet Income Statement Trial Balance 4. Prepare a Trial Balance 5. Prepare Financial Reports 3. Enter transactions in General Ledger General Ledger Ledger Ledger Ledger Ledger 1. Transactions occur Transaction #1 Transaction #2 Transaction #3 Transaction #4 Transaction #5 Transaction #6 Transaction #7 Transaction #8 Special Journals 2. Special Journals Cash Receipts Journal Cash Payments Journal Sales Journal Purchase Journal Closing is required to complete the last step of the Accounting System The Accounting System… 10.2 WHY ARE LEDGERS CLOSED?
- 4. © Michael Allison, Trinity Grammar School. Author’s permission required for external use There are underlying Qualitative Characteristics and Accounting Principles that make closing the General Ledger necessary… Relevance • Revenues and Expenses for 2015 are NOT relevant to 2016’s profit • Resetting to zero all Revenue and Expense accounts allows items to be matched to the relevant period in which they occurred 2015 2016 2015 Sales [R] 30/6 Cash at Bank 70000 2016 Sales [R]2015 Sales [R] 30/6 70000 30/6 Cash at Bank 70000 70000 70000 10.2 WHY ARE LEDGERS CLOSED?
- 5. © Michael Allison, Trinity Grammar School. Author’s permission required for external use There are underlying Qualitative Characteristics and Accounting Principles that make closing the General Ledger necessary… Reporting Period Principle • The firm must break it life into reporting period of equal length – profit is calculated by matching all revenues against expenses • On the first day of the new reporting period, the balance of all revenues and expenses is reset to zero so profit can be calculated for the new period 2015 2016 2015 Sales [R] 30/6 Cash at Bank 70000 2016 Sales [R]2015 Sales [R] 30/6 70000 30/6 Cash 70000 70000 70000 2015 Wages [E] 30/6 Cash 30000 2016 Wages [E]2015 Wages [E] 30/6 Cash 30000 30/6 3000 30000 30000 10.2 WHY ARE LEDGERS CLOSED?
- 6. © Michael Allison, Trinity Grammar School. Author’s permission required for external use Ledger balances at end of period… Account types… Qualitative characteristic or Accounting principle Summary of balancing versus closing… Closing Balancing • Carry forward into next period • Reset to zero • Assets • Liabilities • Owner’s Equity • Revenues • Expenses • Going concern • Relevance • Reporting period 10.2 WHY ARE LEDGERS CLOSED?
- 7. © Michael Allison, Trinity Grammar School. Author’s permission required for external use TASK In-class Homework SQ3 X SQ4 X