Closing Entry in Accounting for Dummies: Definition, Example, and Best Practices

These accounts carry forward their balances throughout multiple accounting periods. From this trial balance, as we learned in the prior section, you make your financial statements. After the financial statements are finalized and you are 100 percent sure that all the adjustments are posted and everything is in balance, you create and post the closing entries. The closing entries are the last journal entries that get posted to the ledger. The end result is equally accurate, with temporary accounts closed to the retained earnings account for presentation in the company’s balance sheet.

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. However, you might wonder, “Where are the revenue, expense, and dividend accounts?” Trial balances often filter out accounts with zero balances. If we expand the view, we’ll find the usual suspects—the temporary accounts.

  1. In corporations, income summary is closed to the retained earnings account.
  2. On the statement of retained earnings, we reported theending balance of retained earnings to be $15,190.
  3. Whether you’re processing closing entries manually, or letting your accounting software do the work, closing entries are perhaps the most important part of the accounting cycle.
  4. After the closing journal entry, the balance on the drawings account is zero, and the capital account has been reduced by 1,300.

Answer the following questions on closing entriesand rate your confidence to check your answer. The income statement reflects your net income for the month of December. The number of closing activities may be quite substantially longer than the list shown here, depending upon the complexity of a company’s operations and the number of subsidiaries whose results must be consolidated. Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own.

Step 3: Close Income Summary to the appropriate capital account

The balance in the Income Summary account equals the net income or loss for the period. This balance is then transferred to the Retained Earnings account. All the temporary accounts, how to put opening balance in wave accounting including revenue, expense, and dividends, have been reset to zero. The balances from these temporary accounts have been transferred to the permanent account, retained earnings.

The balances of these accounts are eventually used to construct the income statement at the end of the fiscal year. The four-step method described above works well because it provides a clear audit trail. For smaller businesses, it might make sense to bypass the income summary account and instead close temporary entries directly to the retained earnings account. 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. If this is the case, then this temporary dividends account needs to be closed at the end of the period to the capital account, Retained Earnings.

Practice Questions: Types of Accounts

We’ll use a company called MacroAuto that creates and installs specialized exhaust systems for race cars. Here are MacroAuto’s accounting records simplified, using positive numbers for increases and negative numbers for decreases instead of debits and credits in order to save room and to get a higher-level view. 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”. The Income Summary balance is ultimately closed to the capital account. An accounting year-end which is not the calendar year end is sometimes referred to as a fiscal year end.

There are four closing entries, which transfer all temporary account balances to the owner’s capital account. A temporary account is an income statement account, dividend account or drawings account. It is temporary because it lasts only for the accounting period. At the end of the accounting period, the balance is transferred to the retained earnings account, and the account is closed with a zero balance. For each temporary account there will be a closing journal entry.

Journalizing and Posting Closing Entries

When you close your books at year-end, the accounts aren’t erased; instead, their balances are transferred to a permanent retained earnings account. Occasionally, revenue and expenses are transferred to an intermediate account called an income summary. Dividends are always transferred directly to retained earnings. Regularly closing your books will prevent unwanted changes from occurring to your accounting data after you generate important financial reports for your accountant or tax professional.

The first entry closes revenue accounts to the Income Summary account. The second entry closes expense accounts to the Income Summary account. The third entry closes the Income Summary account to Retained Earnings. The fourth entry closes the Dividends account to Retained Earnings. The information needed to prepare closing entries comes from the adjusted trial balance.

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. In summary, permanent accounts hold balances that persist from one period to another. In contrast, temporary accounts capture transactions and activities for a specific period and require resetting to zero with closing entries. 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. The purpose of the closing process for each period is to avoid incorrectly recording income or expenses in previous periods. We see fromthe adjusted trial balance that our revenue accounts have a creditbalance.

In other words, it contains net income or the earnings figure that remains after subtracting all business expenses, depreciation, debt service expense, and taxes. The income summary account doesn’t factor in when preparing financial statements because its only purpose is to be used during the closing process. 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.

Let’s investigate an example of how closing journal entries impact a trial balance. Imagine you own a bakery business, and you’re starting a new financial year on March 1st. Temporary accounts are accounts in the general ledger that are used to accumulate transactions over a single accounting period.

This is the adjusted trial balance that will be used to make your closing entries. While these accounts remain on the books, their balance is reset to zero each month, which is done using closing entries. One of the most important steps in the accounting cycle is creating and posting your closing entries. To close that, we debit Service Revenue for the full amount and credit Income Summary for the same. The income statement summarizes your income, as does income summary.

Below are the T accounts with the journal entries already posted. And so, the amounts in one accounting period should be closed so that they won’t get mixed with those in the next period. Now for this step, we need to get the balance of the Income Summary account. In step 1, we credited it for $9,850 and debited it in step 2 for $8,790. The process of using of the income summary account is shown in the diagram below. The T-account summary for Printing Plus after closing entries are journalized is presented in Figure 5.7.

Examples of Post-Closing Entries in Accounting

So, even though the process today is slightly (or completely) different than it was in the days of manual paper systems, the basic process is still important to understand. 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.

Closing Entries Accounting with Automation

Closing entries are journal entries used to empty temporary accounts at the end of a reporting period and transfer their balances into permanent accounts. Temporary accounts are used to accumulate income statement activity during a reporting 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. Closing entries take place at the end of an accounting cycle as a set of journal entries.