Why the Period-End Close Is a Connected Process
A period-end close is not just a list of adjusting entries. It is a sequence for turning transaction evidence into financial statements and resetting temporary accounts for the next period. A dependable close preserves the link between each journal entry, the ledger balances, the adjusted trial balance, the statements, and the final post-closing trial balance.
The case below uses a hypothetical service corporation completing one month of operations. Amounts are in dollars. The company uses accrual accounting: it recognizes revenue when earned and expenses when incurred, rather than simply when cash changes hands. It has no income tax or interest transactions in this case.
From Transactions to the Unadjusted Trial Balance
At the start of the month, the corporation has cash of $20,000, accounts receivable of $4,000, an allowance for uncollectible accounts of $200 credit, supplies of $1,000, equipment of $12,000, and accumulated depreciation of $2,000 credit. It also has accounts payable of $3,000, common stock of $25,000, and retained earnings of $6,800.
The opening balances satisfy the accounting equation. Assets total $37,000; after subtracting the $2,200 of contra-asset balances, net assets are $34,800. Liabilities and equity also total $34,800. During the month, the corporation earns $9,000 cash and $6,000 on account, collects $3,000 from customers, pays rent of $2,000 and salaries of $2,500, buys $1,200 of supplies and $3,000 of equipment for cash, pays $1,500 of accounts payable, pays $1,000 of dividends, prepays $1,200 of insurance, and receives a $1,800 customer advance.
The transaction entries include the following patterns. Cash service revenue is recorded as a debit to Cash and a credit to Service Revenue. Credit service revenue is a debit to Accounts Receivable and a credit to Service Revenue. The customer advance is a debit to Cash and a credit to Unearned Revenue because the service has not yet been earned. Each entry must balance; posting then updates the affected ledger accounts.
Worked Example: Posting Cash Collection Alongside New Credit Revenue
Before posting two transactions, the ledger shows Accounts Receivable of $8,200 debit and Cash of $15,000 debit. The corporation provides $3,400 of services on account, then collects $4,800 from customers on existing invoices. Find the new balances and show why the cash collection is not revenue a second time. Method: journalize each event separately, then post each debit and credit to its ledger account.
For services provided on account, debit Accounts Receivable $3,400 and credit Service Revenue $3,400. Accounts Receivable becomes $8,200 + $3,400 = $11,600 debit. Service Revenue increases by $3,400.
For the collection, debit Cash $4,800 and credit Accounts Receivable $4,800. Cash becomes $15,000 + $4,800 = $19,800 debit. Accounts Receivable becomes $11,600 − $4,800 = $6,800 debit.
The collection reduces the receivable created by earlier credit sales; it does not create new revenue. The two journal entries each have equal debits and credits: $3,400 in the first and $4,800 in the second. Common mistake avoided: crediting revenue again when collecting an invoice would count the same service twice.
Posting all the month’s transactions gives the following unadjusted balances. These balances precede the period-end estimates and accruals described next.
| Account | Debit | Credit |
|---|---|---|
| Cash | $21,400 | |
| Accounts Receivable | $7,000 | |
| Allowance for Uncollectible Accounts | $200 | |
| Supplies | $2,200 | |
| Prepaid Insurance | $1,200 | |
| Equipment | $15,000 | |
| Accumulated Depreciation | $2,000 | |
| Accounts Payable | $1,500 | |
| Unearned Revenue | $1,800 | |
| Common Stock | $25,000 | |
| Retained Earnings | $6,800 | |
| Service Revenue | $15,000 | |
| Rent Expense | $2,000 | |
| Salaries Expense | $2,500 | |
| Dividends | $1,000 | |
| Total | $52,300 | $52,300 |
Adjusting Entries and the Adjusted Trial Balance
The close now compares ledger balances with information about what has been earned, used, incurred, or remains outstanding at month-end. The case assumes a supplies count finds $700 remaining; one month of a 12-month insurance policy has expired; depreciation for the month is estimated at $300; and the required ending allowance is 5% of ending gross accounts receivable. The company also owes $500 in salaries, has earned $1,000 of services not yet billed, and has earned $600 of the customer advance.
The receivable estimate uses gross accounts receivable after recording the unbilled service: $7,000 + $1,000 = $8,000. The required allowance is 5% × $8,000 = $400. Since the existing allowance is $200 credit, the adjustment is an additional $200 credit. This is the adjustment amount, not the full required ending balance.
Worked Example: Calculating the Receivables Adjustment
Use the month-end facts above to calculate the allowance adjustment and the resulting net receivable. Method: first determine gross ending receivables, then calculate the target allowance, and finally compare it with the allowance already in the ledger.
Gross receivables after the $1,000 of unbilled earned service are $7,000 + $1,000 = $8,000. At the stated 5% estimate, the required ending allowance is $8,000 × 0.05 = $400 credit. The ledger already contains a $200 credit, so the adjustment is $400 − $200 = $200 credit to Allowance for Uncollectible Accounts, with a $200 debit to Bad Debt Expense.
After the adjustment, net receivables are $8,000 − $400 = $7,600. The check is that gross receivables of $8,000 less the ending allowance of $400 equal net receivables of $7,600. Common mistake avoided: recording a $400 adjustment would leave a $600 allowance, because the existing $200 credit must be included in the calculation.
The remaining adjusting entries follow directly from the month-end facts:
- Debit Supplies Expense $1,500 and credit Supplies $1,500: $2,200 available less $700 remaining equals $1,500 used.
- Debit Insurance Expense $100 and credit Prepaid Insurance $100: $1,200 ÷ 12 months = $100 for one month.
- Debit Depreciation Expense $300 and credit Accumulated Depreciation $300.
- Debit Salaries Expense $500 and credit Salaries Payable $500 for salaries incurred but unpaid.
- Debit Accounts Receivable $1,000 and credit Service Revenue $1,000 for earned but unbilled services.
- Debit Unearned Revenue $600 and credit Service Revenue $600 for the part of the customer advance earned this month.
- Debit Bad Debt Expense $200 and credit Allowance for Uncollectible Accounts $200, as calculated above.
After posting the adjustments, the adjusted trial balance has these balances. Contra-assets and liabilities have credit balances; expenses and dividends have debit balances.
| Account | Debit | Credit |
|---|---|---|
| Cash | $21,400 | |
| Accounts Receivable | $8,000 | |
| Allowance for Uncollectible Accounts | $400 | |
| Supplies | $700 | |
| Prepaid Insurance | $1,100 | |
| Equipment | $15,000 | |
| Accumulated Depreciation | $2,300 | |
| Accounts Payable | $1,500 | |
| Unearned Revenue | $1,200 | |
| Salaries Payable | $500 | |
| Common Stock | $25,000 | |
| Retained Earnings | $6,800 | |
| Service Revenue | $16,600 | |
| Rent Expense | $2,000 | |
| Salaries Expense | $3,000 | |
| Supplies Expense | $1,500 | |
| Insurance Expense | $100 | |
| Depreciation Expense | $300 | |
| Bad Debt Expense | $200 | |
| Dividends | $1,000 | |
| Total | $54,300 | $54,300 |
Preparing Statements and Closing the Temporary Accounts
The adjusted trial balance provides the balances needed for the period’s statements. Service revenue is $16,600. Total expenses are $2,000 + $3,000 + $1,500 + $100 + $300 + $200 = $7,100. Net income is therefore $16,600 − $7,100 = $9,500. The income statement reports that period result; the balance sheet reports assets, liabilities, and equity at month-end.
Ending retained earnings equal beginning retained earnings plus net income less dividends: $6,800 + $9,500 − $1,000 = $15,300. The balance sheet check is: cash $21,400 + net receivables $7,600 + supplies $700 + prepaid insurance $1,100 + equipment net of depreciation ($15,000 − $2,300 = $12,700) = total assets of $43,500. Liabilities are $1,500 + $1,200 + $500 = $3,200. Equity is common stock $25,000 plus retained earnings $15,300 = $40,300. Liabilities plus equity equal $3,200 + $40,300 = $43,500.
Revenue, expenses, and dividends are temporary accounts: they report activity for a period and are closed so their next-period balances start at zero. Assets, liabilities, common stock, and retained earnings are permanent accounts; their balances carry forward. One common method uses Income Summary as an intermediate closing account.
Debit Service Revenue $16,600 and credit Income Summary $16,600, bringing Service Revenue to zero.
Debit Income Summary $7,100. Credit Rent Expense $2,000, Salaries Expense $3,000, Supplies Expense $1,500, Insurance Expense $100, Depreciation Expense $300, and Bad Debt Expense $200. Each expense account is now zero.
Income Summary has a $9,500 credit balance because $16,600 − $7,100 = $9,500. Debit Income Summary $9,500 and credit Retained Earnings $9,500.
Debit Retained Earnings $1,000 and credit Dividends $1,000. Dividends is zero, and retained earnings is $6,800 + $9,500 − $1,000 = $15,300.
Worked Example: Checking the Dividend Closing Entry
Suppose a corporation begins a period with retained earnings of $14,000, reports revenue of $12,400 and expenses of $8,900, and pays dividends of $1,000. Determine the correct ending retained earnings and explain the effect of omitting the dividend closing entry. Method: calculate net income first, then apply the retained earnings roll-forward.
Net income is $12,400 − $8,900 = $3,500. Ending retained earnings are $14,000 + $3,500 − $1,000 = $16,500. The closing entries transfer the $3,500 net income credit to Retained Earnings and then debit Retained Earnings and credit Dividends for $1,000.
If the dividend closing entry is omitted, retained earnings remains at $14,000 + $3,500 = $17,500, which is $1,000 too high, and Dividends retains a debit balance. Common mistake avoided: dividends are not an expense in calculating net income, but they do reduce retained earnings.
Post-Closing Checks and Common Traps
After closing, the post-closing trial balance contains only permanent accounts. In the integrated case, the debit balances are Cash $21,400, Accounts Receivable $8,000, Supplies $700, Prepaid Insurance $1,100, and Equipment $15,000, totaling $46,200. The credit balances are Allowance for Uncollectible Accounts $400, Accumulated Depreciation $2,300, Accounts Payable $1,500, Unearned Revenue $1,200, Salaries Payable $500, Common Stock $25,000, and Retained Earnings $15,300, also totaling $46,200.
Equal post-closing totals are an important arithmetic check, but they do not prove that every entry is correct. An omitted transaction, a wrong account, or equal debit-and-credit amounts posted to the wrong accounts can still leave totals equal. The close therefore requires both balance checks and review of the accounting logic.
Check Your Understanding
Work each problem through the relevant stage of the close. Amounts are in dollars.
- A ledger has Cash of $6,000 debit and Accounts Receivable of $5,000 debit. The business performs $2,000 of services on account and then collects $1,500 from customers. What are the new balances of Cash, Accounts Receivable, and Service Revenue? (Answer: Cash $7,500 debit; Accounts Receivable $5,500 debit; Service Revenue increases by $2,000.)
- Supplies have an unadjusted balance of $1,750. A period-end count finds $480 remaining. What adjustment is required, and what is Supplies Expense? (Answer: Debit Supplies Expense $1,270 and credit Supplies $1,270; Supplies Expense is $1,270.)
- Gross receivables at period-end are $12,000. The allowance account currently has a $300 credit balance, and the required ending allowance is 4% of gross receivables. Find the adjustment and net receivables. (Answer: Required allowance $480; adjustment $180 credit to Allowance and $180 debit to Bad Debt Expense; net receivables $11,520.)
- A business has revenue of $18,000 and total expenses of $11,500. Beginning retained earnings are $9,200, and dividends are $1,300. Find net income and ending retained earnings. (Answer: Net income $6,500; ending retained earnings $14,400.)
- After closing, a trial balance still shows Service Revenue with a $2,400 credit balance. What does this indicate, and what should the post-closing trial balance contain instead? (Answer: The revenue account was not closed; record the closing entry to transfer its balance to Income Summary, then close Income Summary as appropriate. The post-closing trial balance should contain only permanent accounts.)