Closing entries are those journal entries made in a manual accounting system at the end of an accounting period to shift the balances in temporary accounts to permanent accounts. 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. Notice that revenues, expenses, dividends, and income summary all have zero balances.

Closing, or clearing the balances, means returning the account to a zero balance. Having a zero balance in these accounts is important so a company can compare performance across periods, particularly with income. It also helps the company keep thorough records of account balances affecting retained earnings. Revenue, expense, and dividend accounts affect retained earnings and are closed so they can accumulate new balances in the next period, which is an application of the time period assumption. The first entry requires revenue accounts close to the Income Summary account.

What are the four closing entries in order?

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. The credit to income summary should equal the total revenue from the income statement. Since dividend and withdrawal accounts are not income statement accounts, they do not typically use the income summary account.

• To make them zero we want to decrease the balance or do the opposite.
• You should recall from your previous material that retained earnings are the earnings retained by the company over time—not cash flow but earnings.
• 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.
• 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.
• The business has been operating for several years but does not have the resources for accounting software.

Closing entries take place at the end of an accounting cycle as a set of journal entries. The closing entries serve to transfer these temporary account balances to permanent entries on the company's balance sheet. This resets the balance of the temporary accounts to zero, ready to begin the next accounting period. This is no different from what will happen to a company at the end of an accounting period.

Automate Closing Entries with Deskera

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 accounts, are carried over from the end of a current period to the beginning of the next period. It is also possible to bypass the income summary account and simply shift the balances in all temporary accounts directly into the retained earnings account at the end of the accounting period.

Four Steps to Complete Closing Entries

This means you are preparing all steps in the accounting cycle by hand. In this chapter, we complete the final steps (steps 8 and 9) of the accounting cycle, the closing process. You will notice that we do not cover step 10, reversing entries. This is an optional step in the accounting cycle that you will learn about in future courses.

Step 4: Close withdrawals to the capital account

The Income Summary account has a new credit balance of $4,665, which is the difference between revenues and expenses in Figure 1.29. The balance in Income Summary is the same figure as what is reported on Printing Plus’s Income Statement. Notice that the balances in the expense accounts are now zero and are ready to accumulate expenses in the next period. The Income Summary account has a new credit balance of $4,665, which is the difference between revenues and expenses (Figure 5.5).

Steps 1 through 4 were covered in Analyzing and Recording Transactions and Steps 5 through 7 were covered in The Adjustment Process. Prepare the closing entries for Frasker Corp. using cash flow statements explained: definition and examples 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.

The retained earnings account is reduced by the amount paid out in dividends through a debit, and the dividends expense is credited. In essence, we are updating the capital balance and resetting all temporary account balances. Income and expenses are closed to a temporary clearing account, usually Income Summary. Afterwards, withdrawal or dividend accounts are also closed to the capital account. This is closed by doing the opposite – debit the capital account (decreasing the capital balance) and credit Income Summary. The next and final step in the accounting cycle is to prepare one last post-closing trial balance.

These accounts are closed directly to retained earnings by recording a credit to the dividend account and a debit to retained earnings. 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.

The income summary account is then closed to the retained earnings account. Understanding the accounting cycle and preparing trial balances is a practice valued internationally. 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.

Clear the balance of the expense accounts by debiting income summary and crediting the corresponding expenses. In partnerships, a compound entry transfers each partner's share of net income or loss to their own capital account. In corporations, income summary is closed to the retained earnings account. Permanent (real) accounts are accounts that transfer balances to the next period and include balance sheet accounts, such as assets, liabilities, and stockholders’ equity. Notice that the balances in interest revenue and service revenue are now zero and are ready to accumulate revenues in the next period.

Prepare the closing entries for Frasker Corp. using the adjusted trial balance provided. 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.