5 1 Describe and Prepare Closing Entries for a Business Principles of Accounting, Volume 1: Financial Accounting

We will debit the revenue accounts and credit the
Income Summary account. The credit to income summary should equal
the total revenue from the income statement. The accounts that need to start with a clean or $0 balance going into the next accounting period are revenue, income, and any dividends from January 2019. To determine the income (profit or loss) from the month of January, the store needs to close the income statement information from January 2019.

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, drawing account overview usage and features accounting entry the same final balance is in
retained earnings. Closing entries are journal entries made at the end of an accounting period, that transfer temporary account balances into a permanent account. Notice that the balances in the expense accounts are now zero and are ready to accumulate expenses in the next period.

  • Companies are required to close their books at the end of each
    fiscal year so that they can prepare their annual financial
    statements and tax returns.
  • The income summary account serves as a temporary account used only during the closing process.
  • In partnerships, a compound entry transfers each partner’s share of net income or loss to their own capital account.
  • Now that we have closed the
    temporary accounts, let’s review what the post-closing ledger
    (T-accounts) looks like for Printing Plus.
  • Temporary accounts include all revenue and expense accounts, and also withdrawal accounts of owner/s in the case of sole proprietorships and partnerships (dividends for corporations).

This is an optional step
in the accounting cycle that you will learn about in future
courses. Steps 1 through 4 were covered in
Analyzing and Recording Transactions and Steps 5 through 7
were covered in
The Adjustment Process. Remember that all revenue, sales, income, and gain accounts are closed in this entry. 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.

How to Prepare Your Closing Entries

The balance sheet’s assets, liabilities, and owner’s equity accounts, however, are not closed. These permanent accounts and their ending balances act as the beginning balances for the next accounting period. A closing entry is a journal entry that is made at the end of an accounting period to transfer balances from a temporary account to a permanent account. If dividends were not declared, closing entries would cease at
this point. If dividends are declared, to get a zero balance in the
Dividends account, the entry will show a credit to Dividends and a
debit to Retained Earnings. As you will learn in
Corporation Accounting, there are three components to the
declaration and payment of dividends.

In some cases, accounting software might automatically handle the transfer of balances to an income summary account, once the user closes the accounting period. The entries take place “behind the scenes,” often with no income summary account showing in the chart of accounts or other transaction records. After preparing the closing entries above, Service Revenue will now be zero. The expense accounts and withdrawal account will now also be zero.

For this reason, these types of accounts are called temporary or nominal accounts. When an accountant closes an account, the account balance returns to zero. Starting with zero balances in the temporary accounts each year makes it easier to track revenues, expenses, and withdrawals and to compare them from one year to the next.

  • The purpose of closing entries is to prepare the temporary accounts for the next accounting period.
  • Temporary accounts are income statement accounts that are used to track accounting activity during an accounting period.
  • For corporations, Income Summary is closed entirely to “Retained Earnings”.
  • Are the value of your assets and liabilities now zero because of the start of a new year?

The closing entry will credit Supplies Expense, Depreciation Expense–Equipment, Salaries Expense, and Utility Expense, and debit Income Summary. A term often used for closing entries is “reconciling” the company’s accounts. Accountants perform closing entries to return the revenue, expense, and drawing temporary account balances to zero in preparation for the new accounting period. If a company’s revenues are greater than its expenses, the closing entry entails debiting income summary and crediting retained earnings. In the event of a loss for the period, the income summary account needs to be credited and retained earnings reduced through a debit.

1 Describe and Prepare Closing Entries for a Business

Notice that the Income Summary account is now zero and is ready for use in the next period. The Retained Earnings account balance is currently a credit of $4,665. Printing Plus has a $4,665 credit balance in its Income Summary account before closing, so it will debit Income Summary and credit Retained Earnings. It is the end of the year, December 31, 2018, and you are reviewing your financials for the entire year. You see that you earned $120,000 this year in revenue and had expenses for rent, electricity, cable, internet, gas, and food that totaled $70,000.

All of these entries have emptied the revenue, expense, and income summary accounts, and shifted the net profit for the period to the retained earnings account. Temporary accounts are accounts in the general ledger that are used to accumulate transactions over a single accounting period. The balances of these accounts are eventually used to construct the income statement at the end of the fiscal year. ‘Total expenses‘ account is credited to record the closing entry for expense accounts. After closing, the balance of Expenses will be zero and the account will be ready for the expenses of the next accounting period. 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.

Overview: What are closing entries?

The Philippines Center for
Entrepreneurship and the government of the Philippines hold regular
seminars going over this cycle with small business owners. They are
also transparent with their internal trial balances in several key
government offices. Check out this article
talking about the seminars on the accounting cycle and this
public pre-closing trial balance presented by the Philippines
Department of Health. The $1,000 net profit balance generated through the accounting period then shifts. This is from the income summary to the retained earnings account.

Step 4: Transfer Balance

We have completed the first two columns and now we have the final column which represents the closing (or archive) process. 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). For corporations, Income Summary is closed entirely to “Retained Earnings”.

Step 2: Close all expense accounts to Income Summary

Are the value of your assets and
liabilities now zero because of the start of a new year? Your car,
electronics, and furniture did not suddenly lose all their value,
and unfortunately, you still have outstanding debt. 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.

Therefore, it will not appear on any trial balances, including the
adjusted trial balance, and will not appear on any of the financial
statements. Closing your accounting books consists of making closing entries to transfer temporary account balances into the business’ permanent accounts. Examples of temporary accounts are the revenue, expense, and dividends paid accounts. Any account listed in the balance sheet (except for dividends paid) is a permanent account.

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.

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