Closing Entries: Step by Step Guide

Do you want to learn more about debit, credit entries, and how to record your journal entries properly? Then, head over to our guide on journalizing transactions, with definitions and examples for business. Now, it’s time to close the income summary to the retained earnings (since we’re dealing with a company, not a small business or sole proprietorship). Thus, the income summary temporarily holds only revenue and expense balances. As stated in the name, Temporary accounts are temporary and will last until the end of the fiscal period.

The use of closing entries resets the temporary accounts to begin accumulating new transactions in the next period. Otherwise, the balances in these accounts would be incorrectly included in the totals for the following reporting period. The retained earnings account balance has now increased to 8,000, and forms part of the trial balance after the closing journal entries have been made.

  • 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.
  • While some businesses would be very happy if the balance in Notes Payable reset to zero each year, I am fairly certain they would not be happy if their cash disappeared.
  • Let’s move on to learn about how to record closing those temporary accounts.
  • The purpose of closing entries is to prepare the temporary accounts for the next accounting period.
  • At this point in the accounting cycle, we have prepared the financial statements.

Manually creating your closing entries can be a tiresome and time-consuming process. And unless you’re extremely knowledgeable in how the accounting cycle works, it’s likely you’ll make a few accounting errors along the way. Now, the income summary account has a zero balance, whereas net income for the year ended appears as an increase (or credit) of $14,750. 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. 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. As you can tell by the examples of Temporary Accounts, they all belong to 3 types of accounts.

Financial and Managerial Accounting

The videos in the adjusting entry section gave you a preview into this process but we will discuss it in more detail. Only income
statement accounts help us summarize income, so only income
statement accounts should go into income summary. 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. 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.

With the use of modern accounting software, this process often takes place automatically. We
have completed the first two columns and now we have the final
column which represents the closing (or archive) process. That’s why most business owners avoid the struggle by investing in cloud accounting software instead.

Temporary and Permanent Accounts

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.

Income Summary

total debit to income summary should match total expenses from the
income statement. The first entry requires revenue accounts close to the Income Summary account. To get a zero balance in a revenue account, the entry will show a debit to revenues and a credit to Income Summary. Printing Plus has $140 of interest revenue and $10,100 of service revenue, each with a credit balance on the adjusted trial balance. The closing entry will debit both interest revenue and service revenue, and credit Income Summary.

Introduction to the Closing Entries

To begin the process, you must have prepared three crucial pieces of information. First, it would help if you found the total balances of all the Revenue, Expense, and Dividends. The third entry requires Income Summary to close to the Retained Earnings account. To get a zero balance in the Income Summary account, there are guidelines to consider. 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.

Everything You Need To Build Your Accounting Skills

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. No matter which way you choose to close, the same final balance is in retained earnings.

Step 3: Close and Credit

The main purpose of these closing entries is to bring the temporary journal account balances to zero for the next accounting period, which keeps the accounts reconciled. This process ensures that your temporary accounts are properly closed out sequentially, and the relevant balances are transferred to the income summary and ultimately to the retained earnings account. We see from
the adjusted trial balance that our revenue accounts have a credit
balance. To make them zero we want to decrease the balance or do
the opposite. We will debit the revenue accounts and credit the
Income Summary account.