Closing Entries: Step by Step Guide

The purpose of closing entries is to prepare the temporary accounts for the next accounting period. In other words, the income and expense accounts are “restarted”. Since dividend and withdrawal accounts are not income statement accounts, they do not typically use the income summary account.

• In step 1, we credited it for $9,850 and debited it in step 2 for $8,790.
• This time period, called the accounting period, usually reflects one fiscal year.
• Accountants may perform the closing process
  monthly or annually.
• At this point, the credit column of the Income Summary represents the firm’s revenue, the debit column represents the expenses, and balance represents the firm’s income for the period.

A net loss would decrease owner’s capital, so we would do the opposite in this journal entry by debiting the capital account and crediting Income Summary. However, some corporations use a temporary clearing account for dividends declared (let’s use “Dividends”). They’d record declarations by debiting Dividends Payable and crediting Dividends.

Closing Entries: Definition, Types, and Examples

Printing Plus has $100 of supplies expense, $75 of depreciation
expense–equipment, $5,100 of salaries expense, and $300 of utility
expense, each with a debit balance on the adjusted trial balance. The closing entry will credit Supplies Expense, Depreciation
Expense–Equipment, Salaries Expense, and Utility Expense, and debit
Income Summary. The income summary account is a temporary account solely for posting entries during the closing process. It is a holding account for revenues and expenses before they are transferred to the retained earnings account.

• Accounts are considered “temporary” when they only accumulate transactions over one single accounting period.
• Now that all the temporary accounts are closed, the income summary account should have a balance equal to the net income shown on Paul’s income statement.
• The
  third entry closes the Income Summary account to Retained Earnings.
• Closing entries prepare a company for the next
  accounting period by clearing any outstanding balances in certain
  accounts that should not transfer over to the next period.

This means that the
current balance of these accounts is zero, because they were closed
on December 31, 2018, to complete the annual accounting period. No, closing entries are performed after adjusting entries in the accounting cycle. Adjusting entries ensure that revenues and expenses are appropriately recognized in the correct accounting period.

Four Steps in Preparing Closing Entries

The balance in Income Summary is the same figure as what
is reported on Printing Plus’s Income Statement. You might be asking yourself, “is the Income Summary account
even necessary? ” Could we just close out revenues and expenses
directly into retained earnings and not have this extra temporary
account? We could do this, but by having the Income Summary
account, you get a balance for net income a second time. This gives
you the balance to compare to the income statement, and allows you
to double check that all income statement accounts are closed and
have correct amounts. If you put the revenues and expenses directly
into retained earnings, you will not see that check figure.

Step 4: Closing the drawing/dividends account

In this example, it is assumed that there is just one expense account. Expense accounts have a debit balance, so you’ll have to credit their respective balances and debit income summary in order to close them. This time period, called the accounting period, usually reflects one fiscal year. However, your business is also free to handle closing entries monthly, quarterly, or every six months. All of Paul’s revenue or income accounts are debited and credited to the income summary account.

Example of a Closing Entry

Since we credited income summary in Step 1 for $5,300 and debited income summary for $5,050 in Step 2, the balance in the income summary account is now a credit of $250. Revenue is one of the four accounts that needs to be closed to the income summary account. This is the adjusted trial balance that will be used to make your closing entries. One of the most important steps in the accounting cycle is creating and posting your closing entries.

It is
important to understand retained earnings is not closed out, it is only updated. Retained
Earnings is the only account that appears in the closing entries
that does not close. You should recall from your previous material
that retained earnings are the earnings retained by the company
over time—not cash flow but earnings. Now that we have closed the
temporary accounts, let’s review what the post-closing ledger
(T-accounts) looks like for Printing Plus. Temporary (nominal) accounts are accounts that
are closed at the end of each accounting period, and include income
statement, dividends, and income summary accounts.

Once the closing entries have been posted, the trial balance calculation is performed to help detect any errors that may have occurred in the closing process. Any remaining balances will now be transferred and a post-closing trial balance will be reviewed. The fourth entry requires Dividends to close to the Retained Earnings account. Remember from your past studies that dividends are not expenses, such as salaries paid to your employees or staff. Instead, declaring and paying dividends is a method utilized by corporations to return part of the profits generated by the company to the owners of the company—in this case, its shareholders. The eighth step in the accounting cycle is preparing closing entries, which includes journalizing and posting the entries to the ledger.

The total of the income summary account after the all temporary accounts have been close should be equal to the net income for the period. At the end of the year, all the temporary accounts must be closed or reset, so the beginning of the following year will have a clean balance to start with. In other words, revenue, expense, and withdrawal accounts always have a zero balance at the start of the year because they are always closed at the end of the previous year. A net loss would decrease retained earnings so we
would do the opposite in this journal entry by debiting Retained
Earnings and crediting Income Summary. Our discussion here begins with journalizing and posting the closing entries (Figure 5.2).

Temporary Accounts:

Notice that the balances in interest revenue and service revenue are now zero and are ready to accumulate revenues in the next period. The Income Summary account has a credit balance of $10,240 (the revenue sum). Permanent (real) accounts are accounts that transfer balances to the next period and include balance sheet accounts, such as assets, liabilities, and stockholders’ equity. These accounts will not be set back to zero at the beginning of the next period; they will keep their balances.

The T-account summary for Printing Plus after closing entries are journalized is presented in Figure 5.7. Let’s explore each entry in more detail using Printing Plus’s information from Analyzing and Recording Transactions and The Adjustment Process as our example. The Printing Plus adjusted trial balance for January 31, 2019, is presented in Figure 5.4.

Temporary accounts are used to record accounting activity during a specific period. All revenue and expense accounts must end with a zero balance because they are reported in defined periods and are not carried over into the future. For example, $100 in revenue this year does not count as $100 of revenue for next year, even if the company retained the funds for use in the next 12 months. Once all of the required entries farmfact farm accounting software have been made, you can run your post-closing trial balance, as well as other reports such as an income statement or statement of retained earnings. Now that the journal entries are prepared and posted, you are almost ready to start next year. Remember, modern computerized accounting systems go through this process in preparing financial statements, but the system does not actually create or post journal entries.