Closing Entry Definition, Explanation, and Examples

Bookkeeping

Closing Entry Definition, Explanation, and Examples

At the end of the period, the balances in these accounts are transferred to the retained earnings account or another permanent account, which represents the cumulative earnings of the company since its inception. The balance in dividends, revenues and expenses would all be zero leaving only the permanent accounts for a post closing trial balance. The trial balance shows the ending balances of all asset, liability and equity accounts remaining. The main change from an adjusted trial balance is revenues, expenses, and dividends are all zero and their balances have been rolled into retained earnings.

Step 3: Close Income Summary account

It’s vital in business to keep a detailed record of your accounts. Answer the following questions on closing entries and rate your confidence to check your answer. Answer the following questions on closing entriesand rate your confidence to check your answer. All accounts can be classified as either permanent (real) ortemporary (nominal) (Figure5.3). Instead,  as a form of distribution of a firm’s accumulated earnings, dividends are treated as a distribution of equity of the business. The Statement shows Cash’s business transactions, whether inflow or outflow.

Step 1 of 3

The cost of goods sold is an account that displays the balance of the total cost amount that the company used to produce the products sold. To find the Expenses, just like for Revenue, you would also find it in the Income Statement. The expenses would be listed in the expense section, so you would need to find the total costs. Depending on the company, there could be many different expenses.

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• We don’t want the 2015 revenue account to show 2014 revenue numbers.
• 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.
• 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.
• Notice that the Income Summary account is now zero and is readyfor use in the next period.
• All temporary accounts must be reset to zero at the end of the accounting period.
• Once this is done, it is then credited to the business’s retained earnings.
• Closing entries are put into action on the last day of an accounting period.

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”. We see fromthe adjusted trial balance that our revenue accounts have a creditbalance. To make them zero we want to decrease the balance or dothe opposite. We will debit the revenue accounts and credit theIncome Summary account.

Both closing entries are acceptable and both result in the same outcome. All temporary accounts eventually get closed to retained earnings and are presented on the balance sheet. Closing all temporary accounts to the retained earnings account is faster than using the income summary account method because it saves a step. There is no need to close temporary accounts to another temporary account (income summary account) in order to then close that again. Temporary accounts are income statement accounts that are used to track accounting activity during an accounting period. For example, the revenues account records the amount of revenues earned during an accounting period—not during the life of the company.

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A net loss would decrease retained earnings so wewould do the opposite in this journal entry by debiting RetainedEarnings and crediting Income Summary. Once all of the required entries 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. These entries are made to update retained earnings to reflect the results of operations and to eliminate the balances in the revenue and expense accounts, enabling them to be used again in a subsequent period. After the posting of this closing entry, the income summary now has a credit balance of $14,750 ($70,400 credit posted minus the $55,650 debit posted). The purpose of closing entries is to merge your accounts so you can determine your retained earnings.

The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. For information pertaining to the registration status of 11 Financial, please contact the state securities regulators for those states in which 11 Financial maintains a registration filing. Now, if you’re new to accounting, you probably have a ton of questions. Preparing for the Closing Entry is simple and quick, as all the required information can be easily found. Closing Entries are designed after the Financial Statements for the fiscal periods are created, which means all the needed information is already there; you just need to find it.

Now that we know the basics of closing entries, in theory, let’s go over the step-by-step process of the entire closing procedure through a practical business example. Keep in mind, however, that this account is only purposeful for closing the books, and thus, it is not recorded into any accounting reports and has a zero balance at the end of the closing process. After most of the cycle is completed and financial statements are generated, there’s one last step in the process known as closing your books. And so, the amounts in one accounting period should be closed so that they won’t get mixed with those in the next period. For partnerships, each partners’ capital account will be credited based on the agreement of the partnership (for example, 50% to Partner A, 30% to B, and 20% to C).

• Using the above steps, let’s go through an example of what the closing entry process may look like.
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• As mentioned, one way to make closing entries is by directly closing the temporary balances to the equity or retained earnings account.
• The $9,000 of expenses generated through the accounting period will be shifted from the income summary to the expense account.
• A net loss would decrease retained earnings so wewould do the opposite in this journal entry by debiting RetainedEarnings and crediting Income Summary.

Recording a Closing Entry

In summary, the accountant resets thetemporary accounts to zero by transferring the balances topermanent accounts. Closing entries are posted in the general ledger by transferring all revenue and expense account balances to the income summary account. Then, transfer the balance of the income summary account to the retained earnings account. Finally, transfer any dividends to the retained earnings account.

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. Thebusiness has been operating for several years but does not have theresources for accounting software.