Closing Entry Definition, Explanation, and Examples

However, if the company also wanted to keep year-to-date information from month to month, a separate set of records could be kept as the company progresses through the remaining months in the year. For our purposes, assume that we are closing the books at the end of each month unless otherwise noted. If your expenses for December had exceeded your revenue, you would have a net loss. When closing expenses, you should list them individually as they appear in the trial balance.

Closing entries help in the reconciliation of accounts which facilitates in controlling the overall financials of a firm. All accounts can be classified as either permanent (real) or
temporary (nominal) (Figure
5.3). It’s vital in business to keep a detailed record of your accounts.

  • If a company’s revenues are greater than its expenses, the closing entry entails debiting income summary and crediting retained earnings.
  • 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.
  • Our discussion here begins with journalizing and posting the closing entries (Figure 5.2).
  • All revenue accounts are first transferred to the income summary.
  • Revenue and expense accounts are closed to Income Summary, and
    Income Summary and Dividends are closed to the permanent account,
    Retained Earnings.

Take note that closing entries are prepared only for temporary accounts. The next and final step in the accounting cycle is to prepare one last post-closing trial balance. Understanding the accounting cycle and preparing trial balances
is a practice valued internationally.

Practice Questions: Types of Accounts

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. Permanent accounts are accounts that show the long-standing financial position of a company. These accounts carry forward their balances throughout multiple accounting periods.

  • When making closing entries, the revenue, expense, and dividend account balances are moved to the retained earnings permanent account.
  • If your business is a sole proprietorship or a partnership, your next step will be to close your income summary account.
  • The statement of retained earnings shows the period-ending retained earnings after the closing entries have been posted.
  • If a corporation has more than one class of stock and uses dividend accounts to record dividend payments to investors, it usually uses a separate dividend account for each class.

The first part is the date of
declaration, which creates the obligation or liability to pay the
dividend. The second part is the date of record that determines who
receives the dividends, and the third part is the date of payment,
which is the date that payments are made. Printing Plus has $100 of
dividends with a debit balance on the adjusted trial balance.

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. 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.

A closing entry is a journal entry made at the end of accounting periods that involves shifting data from temporary accounts on the income statement to permanent accounts on the balance sheet. Temporary accounts include revenue, expenses, and dividends, and these accounts must be closed at the end of the accounting year. To update the balance in the owner’s capital account, accountants close revenue, expense, and drawing accounts at the end of each fiscal year or, occasionally, at the end of each accounting period.

Step 4: Close withdrawals account

All expense accounts are then closed to the income summary account by crediting the expense accounts and debiting income summary. 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. After this closing entry has been posted, each of these revenue accounts has a zero balance, whereas the Income Summary has a credit balance of $7,400. The income summary account is an intermediary between revenues and expenses, and the Retained Earnings account. It stores all of the closing information for revenues and expenses, resulting in a “summary” of income or loss for the period.

What Are Closing Entries?

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 notes payable balances. The next day, January 1, 2019, you get ready for work, but
before you go to the office, you decide to review your financials
for 2019. What are your total expenses for
rent, electricity, cable and internet, gas, and food for the
current year? You have also not incurred any expenses yet for rent,
electricity, cable, internet, gas or food.

Once this closing entry is made, the revenue account balance will be zero and the account will be ready to accumulate revenue at the beginning of the next accounting period. In this example we will close Paul’s Guitar Shop, Inc.’s temporary accounts using the income summary account method from his financial statements in the previous example. In this case, if you paid out a dividend, the balance would be moved to retained earnings from the dividends account. Once this has been completed, a post-closing trial balance will be reviewed to ensure accuracy.

Revenues and expenses are transferred to the Income Summary account, the balance of which clearly shows the firm’s income for the 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. Now Paul must close the income summary account to retained earnings in the next step of the closing entries. First, all the various revenue account balances are transferred to the temporary income summary account. This is done through a journal entry that debits revenue accounts and credits the income summary.

What Is a Closing Entry?

Our discussion here begins with journalizing and posting the
closing entries (Figure
5.2). These posted entries will then translate into a
post-closing trial balance, which is a trial
balance that is prepared after all of the closing entries have been
recorded. Closing all temporary accounts to the income summary account leaves an audit trail for accountants to follow. 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. Closing entries, on the other hand, are entries that close temporary ledger accounts and transfer their balances to permanent accounts.

Closing Entry Shortcuts and Software Handling

The expense accounts have debit balances so to get rid of their balances we will do the opposite or credit the accounts. Just like in step 1, we will use Income Summary as the offset account but this time we will debit income summary. The total debit to income summary should match total expenses from the income statement. Closing entries are the journal entries used to transfer the balances of these temporary accounts to permanent accounts.

Closing Entry for Income Summary

Only income
statement accounts help us summarize income, so only income
statement accounts should go into income summary. Temporary accounts can either be closed directly to the retained earnings account or to an intermediate account called the income summary account. The income summary account is then closed to the retained earnings account. 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.

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. Thus, the income summary temporarily holds only revenue and expense balances. All modern accounting software automatically generates closing entries, so these entries are no longer required of the accountant; it is usually not even apparent that these entries are being made. Prepare the closing entries for Frasker Corp. using the adjusted trial balance provided. The income statement summarizes your income, as does income summary. If both summarize your income in the same period, then they must be equal.