Closing Revenue, Expense and Inventory Accounts at the End of the Financial Period

Explanation

At the end of each financial period, a sole proprietor must close the revenue and expense accounts before preparing the financial statements. Revenue accounts (such as Sales, Discount Received and Commission Received) and expense accounts (such as Purchases, Salaries, Rent and Insurance) are known as nominal accounts or temporary accounts. These accounts measure performance for one period only, so their balances cannot be carried forward to the next period. This differs from permanent accounts (real accounts) such as assets, liabilities and capital, whose balances are brought down (balance b/d) into the new period.

Revenue and expense accounts are closed so that the profit or loss of the business can be determined accurately. If nominal accounts are not closed, the revenue and expenses of the previous period would mix with the new period and produce an incorrect profit or loss figure. Through the closing process, all revenue and expense balances are transferred to the Trading Account or the Profit and Loss Account so that the nominal account balances become zero. In this way, the revenue and expense accounts start again from zero in each financial period.

Procedure to close revenue accounts: a revenue account normally has a credit balance. To close it, the revenue account is debited and the Trading Account or Profit and Loss Account is credited on the last date of the period. The Sales account is closed and transferred to the credit side of the Trading Account (Debit Sales; Credit Trading Account). Other revenue apart from sales, such as Discount Received, Commission Received and Rent Received, is closed and transferred to the credit side of the Profit and Loss Account (Debit revenue account; Credit Profit and Loss Account).

Procedure to close expense accounts: an expense account normally has a debit balance. To close it, the expense account is credited and the Trading Account or Profit and Loss Account is debited. Direct expenses such as Purchases, Carriage Inwards and Duty on Purchases are transferred to the debit side of the Trading Account (Debit Trading Account; Credit Purchases). Other expenses such as Salaries, Rent, Insurance, Rates and General Expenses are transferred to the debit side of the Profit and Loss Account (Debit Profit and Loss Account; Credit expense account). Returns accounts are also closed: Returns Inwards go to the debit of the Trading Account (reducing sales), while Returns Outwards go to the credit of the Trading Account (reducing purchases).

The Inventory Account is handled differently because it is a permanent account, not a nominal account. Opening inventory (the debit balance at the start of the period) is transferred to the debit side of the Trading Account with the entry Debit Trading Account; Credit Inventory Account. Closing inventory, valued at the last date of the period, is recorded with the entry Debit Inventory Account; Credit Trading Account. The Inventory Account balance (that is, the value of closing inventory) is then brought down as balance b/d and becomes the opening inventory for the next financial period. Therefore, the Inventory Account is not closed to zero like revenue and expense accounts.

Worked examples

Practice

Exam tips

Key terms

Nominal account

A temporary account (revenue and expense) that is closed at period end so its balance becomes zero.

Trading Account

The account to which Sales, Purchases, Returns and Inventory are transferred to compute gross profit.

Profit and Loss Account

The account to which other revenue and general expenses are transferred to compute net profit.

Inventory Account

A permanent account for inventory; closing inventory is brought down as balance b/d and not closed to zero.

Source: DSKP KSSM Prinsip Perakaunan Tingkatan 4

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