Closing The Accounts - Jim's Strawberry Farm

We have seen how the accounts accumulate the totals of the Revenue, Expense, Asset, Liability, and Owners Equity items.

Having reached the end of an accounting year and taken out a Trial Balance we,

(1) Close off all the balances of revenue and expense accounts to the Profit Determining accounts.
The Revenue and Expense accounts are then ready to receive the entries for revenue and expense for the new accounting period.

(2) Transfer the balance of the Profit Determining accounts (i.e. the profit or loss) to the relevant Owners Equity account.

Lets see how this works in practice.

Listed below are all the accounts with their balances for Jim's Strawberry Farm.

In calculating Profit we are only interested in the Revenue and Expense accounts, the ones in blue.

We include the Inventory account, used to calculate the change in stock levels and Owners Equity account where Net Profit end up.

All the other accounts balances, Assets and Liabilities are ignored.

To these we add two new Accounts, a Trading Account to calculate Gross Profit.
and a Profit & Loss Account to calculate Net Profit.

As we will see these Profit Determining Accounts have a brief existence and are closed once Profit has been determined.

Now we begin the process of transferring the balances out of the revenue and expenses accounts to these accounts.

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