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3 4 Purpose of the closing process and prepare closing entries Accounting Business and Society

3 4 Purpose of the closing process and prepare closing entries Accounting Business and Society

Then, expenses like salaries and rent are also closed in the same way. Lastly, the balance of the Income Summary is moved to the Retained Earnings or Owner’s Equity Account. If your business is a corporation, you will not have a drawing account, but if you paid stockholders, you will have a dividends account.

Businesses are required to close their books at the end of each accounting period. 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. Closing, or clearing the balances, means returning the account to a zero balance. Having a zero balance in these accounts is important so a business can compare performance across periods, particularly with income.

What is a closing entry?

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. Accurate and timely financial reporting is a must for many organizations. The income statement reflects your net income for the month of December.

Temporary accounts are used to compile transactions that impact the profit or loss of a business during a year, while permanent accounts maintain an ongoing balance over time. 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.

Closing Entry

To further clarify this, balances are closed to ensure all revenues and expenses are recorded in the proper period and then start over the following period. The revenue and expense accounts should start at zero each period because we are measuring how much revenue is earned and expenses incurred during the period. However, the cash balances, as well as the other balance sheet (permanent) accounts, are carried over from the end of a current period to the beginning of the next period. By following a consistent order for closing entries, you can avoid confusion and ensure completeness. Generally, you should start by closing revenue accounts to the income summary account, which is a temporary account that summarizes the net income or loss for the period.

closing entries are made

They make sure bookkeeping is done properly and provide a clear view of and organization’s performance and net income or loss for a specific period. A closing entry is an accounting entry that is used to transfer the balances of temporary accounts to permanent accounts. These are general account ledgers that show balances recorded over multiple periods. These will usually include all balance sheet items like assets, liabilities and equity accounts. Therefore, all those accounts are included for which current balances must be used in the next financial reporting period and for which accounts cannot be closed out. A temporary account records balances for a single accounting period, whereas a permanent account stores balances over multiple periods.

Should closing entries be performed before or after adjusting entries?

If you paid dividends for the month, you will need to close that account as well. While these accounts remain on the books, their balance is reset to zero each month, which is done using closing entries. As a result, the temporary accounts will begin the following accounting year with zero balances. The general ledger is the central repository of all accounts and their balances, including the closing entries. Clear the balance of the revenue account by debiting revenue and crediting income summary.

  • As you will see later, Income Summary is eventually closed to capital.
  • If your business is a corporation, you will not have a drawing account, but if you paid stockholders, you will have a dividends account.
  • In the next accounting period, these accounts usually (but not always) start with a non-zero balance.
  • 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.
  • All drawing accounts are closed to the respective capital accounts at the end of the accounting period.
  • As a result, the temporary accounts will begin the following accounting year with zero balances.

The income summary account is then closed to the retained earnings account. It’s important to note that neither the drawing nor the dividends accounts need to be transferred to the income summary account. The retained closing entries are made earnings account is reduced by the amount paid out in dividends through a debit, and the dividends expense is credited. Next, transfer the $2,500 in your expense account to your income summary account.

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These entries zero out temporary accounts and transfer their balances to permanent accounts. It can directly be closed in the retained earnings account or it can be done through a longer process. The longer process requires temporary accounts to be closed in an intermediate income summary account first and then that account is zeroed out to the retained earnings. The result in both cases is the same and depends on the bookkeeper’s preference or company’s policy on it.

  • Income and expenses are closed to a temporary clearing account, usually Income Summary.
  • One very good site where you can find many tools to help you study this topic is Accounting Coach which provides a tool that is available to you free of charge.
  • Notice that the balances in interest revenue and service revenue are now zero and are ready to accumulate revenues in the next period.
  • You can also use a worksheet to prepare reversing entries, which are optional entries that cancel out some of the adjustments made in the closing process.
  • For sole proprietorships and partnerships, you’ll close your drawing account to your capital account, because you will need to reduce your capital account by the draws taken for the month.
  • It is the end of the year, December 31, 2018, and you are reviewing your financials for the entire year.

All temporary accounts with zero balances were left out of this trial balance. Unlike previous trial balances, the retained earnings figure is included, which was obtained through the closing process. To close the income summary account to the retained earnings account as mentioned earlier, we need to debit the income summary account and credit retained earnings account. This will ensure that the balance has been transferred on the balance sheet. Below are some of the examples of closing entries that can be used to transfer revenue and expense account balances into income summary and from there to the retained earnings. Your closing journal entries serve as a way to zero out temporary accounts such as revenue and expenses, ensuring that you begin each new accounting period properly.

Step 4: Close withdrawals to the capital account

Imagine you own a bakery business, and you’re starting a new financial year on March 1st. Whether you credit or debit your income summary account will depend on whether your revenue is more than your expenses. Because expenses are decreased by credits, you must credit the account and debit the income summary account.

Are closing entries made so that financial statements can be prepared?

The purpose of the closing procedure is to prepare the financial statements, ensure the accuracy of the financial information, reset temporary account balances to zero for the next accounting period, and update the retained earnings account to reflect the period's net income or net loss.

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