Summary
Highlights
Next, all expense accounts (Cost of Services, Overhead, Interest, Tax) are reset to zero by crediting them. The total balance of 16 million fifty thousand dollars is debited to the Income Summary Account.
Closing entries are journal entries that reset temporary accounts to zero by transferring their balances into retained earnings, a permanent account. They are posted at the end of each accounting period after financial statements are created.
Using the acronym 'RED ALE' (Revenue, Expenses, Dividends for Temporary; Assets, Liabilities, Equity for Permanent), the video explains which accounts are reset at the end of an accounting period and which carry forward their balances.
The video uses an example of a ride-sharing company called 'Unter' to illustrate the process. It starts with an opening trial balance and then moves to an adjusted trial balance after a full year of transactions, highlighting the changes in temporary accounts.
The short way condenses all four steps into one closing entry. All temporary accounts (revenue, expenses, and dividends) are closed directly to retained earnings, resulting in the same final retained earnings balance.
After posting all closing entries, the post-closing trial balance shows that all temporary accounts are at zero, and their balances have been transferred to retained earnings. A recap summarizes both the long and short methods.
The first step in the long method involves resetting the revenue account to zero by debiting it and crediting an 'Income Summary Account' with the balance of 20 million dollars.
The balance in the Income Summary Account, which now reflects the net profit of 3 million nine hundred fifty thousand dollars, is transferred to Retained Earnings by debiting Income Summary and crediting Retained Earnings.
Finally, the dividends account (half a million dollars) is reset to zero by crediting it and debiting Retained Earnings, as dividends reduce retained earnings.