Closing entries will
a. increase the Owner’s Capital balance.
b. decrease the Owner’s Capital balance.
c. not affect the Owner’s Capital balance.
d. either increase or decrease the Owner’s Capital balance.
The correct answer and explanation is :
The correct answer is:
d. either increase or decrease the Owner’s Capital balance.
Explanation:
Closing entries are journal entries made at the end of an accounting period to transfer balances from temporary accounts to permanent accounts. The purpose of closing entries is to reset temporary accounts (such as revenues, expenses, and withdrawals) to zero so that they can start fresh for the next accounting period.
Temporary accounts include:
- Revenue Accounts – These accounts record earnings from sales, services, or other business activities.
- Expense Accounts – These accounts track costs incurred in running the business, such as salaries, rent, and utilities.
- Owner’s Drawings (Withdrawals) – If the owner withdraws money for personal use, it is recorded in this account.
The Owner’s Capital account is a permanent account, meaning its balance carries over to the next accounting period. The closing process impacts the Owner’s Capital balance in the following ways:
- If the business earns a net income (revenues > expenses):
- The revenue and expense accounts are closed, and the net income is transferred to the Owner’s Capital account.
- This increases the Owner’s Capital balance.
- If the business incurs a net loss (expenses > revenues):
- The loss is deducted from the Owner’s Capital account, reducing its balance.
- If the owner has made withdrawals:
- The Owner’s Drawings account is closed and deducted from the Owner’s Capital balance, causing a decrease.
Because closing entries can either increase or decrease the Owner’s Capital balance, the correct answer is (d) either increase or decrease the Owner’s Capital balance.