You need to be careful when working with accrual entries, reversing entries, and then the real entries that follow and correct everything in the end. These tools can be enormously helpful when it’s important to measure expenses and liabilities accurately. You must remember to complete the entire sequence of transactions, however; you can’t stop halfway.
One last important point: In journal entries 16, 17, and 18, I talk about how to accrue loan interest expense. You can use this accrual technique to recognize any liability — a fact that I want to emphasize. You can use the technique demonstrated in these journal entries to deal with liabilities for things such as wages owed to employees, taxes owed to the government, and so forth.
Some firms, particularly those with sophisticated accounting systems, can even use this technique to record hard-to-quantify liabilities, such as warranty liabilities. (A warranty is a promise that you make to a customer. You might promise that your product won’t break, for example.) These promises create liabilities and expenses. An accurate accounting system requires that you record these expenses as they occur and recognize these liabilities as they come into existence.
Closing Out Revenue and Expense Accounts
You’re about to enter the twilight zone of accounting. In this section, I talk about what happens to revenue and expense accounts at the end of the year in traditional manual accounting systems. Then I explain why QuickBooks doesn’t quite work that way and what you need to do about it.
If you want to skip anything in this chapter, this section may be that material. On the other hand, if you (like me) have a compulsive personality and deem it essential to read everything in this chapter (even stuff that’s not particularly exciting), read on.
Book 1, Chapter 1 and Book 1, Chapter 2 describe an imaginary hot dog stand, a one-day business that (in my imagination) you operate. (If you’ve been reading this chapter and have no questions, you don’t even need to worry about the two preceding chapters.) Table 3-19 shows the trial balance for this business at the end of the day of operation.
TABLE 3-19 A Trial Balance at the End of the Period
| Account | Debit | Credit |
|---|---|---|
| Cash | $5,000 | |
| Inventory | 0 | |
| Accounts payable | $0 | |
| Loan payable | 0 | |
| S. Nelson, capital | 1,000 | |
| Sales revenue | 13,000 | |
| Cost of goods sold | 3,000 | |
| Rent | 1,000 | |
| Wages expense | 4,000 | |
| Supplies | 1,000 | _____ |
| Totals | $14,000 | $14,000 |
The traditional close
As I hope you already know, revenue and expense accounts count revenue and expenses for a particular period of time. Revenue and expense accounts may count for the month, the quarter, or the year, for example.
One thing that accounting systems traditionally do is zero out the revenue and expense accounts at the end of the year. This makes sense if you think about it a bit. You want your counters reset at the beginning of the year so that counting the new year’s revenue and the new year’s expenses is easy. In the case of a trial balance like the one shown in Table 3-19, for example, you’d typically make the journal entry shown in Table 3-20.
TABLE 3-20 Journal Entry 19: Closing the Period
| Account | Debit | Credit |
|---|---|---|
| Sales revenue | $13,000 | |
| Cost of goods sold | $3,000 | |
| Rent | 1,000 | |
| Wages expense | 4,000 | |
| Supplies | 1,000 | |
| Owner’s equity | 4,000 |
If you look at Journal Entry 19 (Table 3-20), for example, you see that the first line in the journal entry is a $13,000 debit for sales revenue. If you look back at the trial balance shown in Table 3-19, you see that sales revenue has a $13,000 credit balance. The combination of the account balance shown in Table 3-19 and the closing entry shown in Journal Entry 19 (Table 3-20) effectively zeros out the sales revenue account.
The same sort of accounting magic occurs for each of the other expense accounts shown in the trial balance. The cost-of-goods-sold balance is equal to a $3,000 debit in Table 3-19 and is zeroed out in Journal Entry 19 with a $3,000 credit. And so it goes.
The QuickBooks close
The sort of accounting taught at local community colleges makes just the sort of closing entry shown in Journal Entry 19, but you don’t need or even want to make such a closing entry within QuickBooks.
The closing entry shown in Journal Entry 19 gets made in a manual system