Closing Entries as Part of the Accounting Cycle

To close the account, we need to debit the income summary account and credit all the relevant individual expenses accounts such as utilities expense, wages expense depreciation expense, etc. To close the account, we need to debit the revenue account and credit the income summary account. Second, the closing process updates the retained earnings account to its correct end of period balance. Recall that the balance in the retained earnings comes from the statement of change in equity and not the adjusted trial balance. The transfer to retained earnings is the mechanism that updates the actual retained earnings account balance in the general ledger.

They are essential for measuring the performance of a business, as they help prepare the income statement and the statement of changes in equity. In this article, you will learn how to use closing entries to assess your business’s profitability, growth, and financial position. The accounts involved in closing journal entries are the temporary accounts for revenue, expenses and dividends, and a permanent account from the balance sheet called retained earnings.

How do you post closing entries?

Any account listed on the balance sheet, barring paid dividends, is a permanent account. On the balance sheet, $75 of cash held today is still valued at $75 next year, even if it is not spent. In essence, we are updating the capital balance and resetting all temporary account balances. To close the drawing account to the capital account, we credit the drawing account and debit the capital account. To close expenses, we simply credit the expense accounts and debit Income Summary. In addition, if the accounting system uses subledgers, it must close out each subledger for the month prior to closing the general ledger for the entire company.

This entry zeros out dividends and reduces retained earnings by total dividends paid. 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. According to the preceding discussion, although there is a distinction between adjusting and closing entries, both aid in the preparation of an organization’s final accounts.

Closing Entry #4 for Bob

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. Instead the balances in these accounts are moved at month-end to either the capital account or the retained earnings account. Corporations will close the income summary account to the retained earnings account.

These journal entries condense your accounts so you can determine your retained earnings, or the amount your business has after paying expenses and dividends. Creating closing entries is one of the last steps of the accounting cycle. These are general account ledgers that record transactions over the period and accounting cycle.

Close Expense Accounts

The income summary is a temporary account used to make closing entries. This is the same figure found on the statement of retained earnings. 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.

• Here we see that total expenses for both were $9,650 for January 2020.
• If you have never followed the full process from beginning to end, you will never understand how one of your decisions can impact the final numbers that appear on your financial statements.
• In the next accounting period, these accounts usually (but not always) start with a non-zero balance.
• These accounts will not be set back to zero at the beginning of the next period; they will keep their balances.
• This allows you to evaluate your business’s performance in terms of profitability, efficiency, and margins.

Your car, electronics, and furniture did not suddenly lose all their value, and unfortunately, you still have outstanding debt. Therefore, these accounts still have a balance in the new year, because they are not closed, and the balances are carried forward from December 31 to January 1 to start the new annual accounting period. 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. When closing the revenue account, you will take the revenue listed in the trial balance and debit it, to reduce it to zero. As a corresponding entry, you will credit the income summary account, which we mentioned earlier. During the accounting period, you earned $5,000 in revenue and had $2,500 in expenses.

Accounting Closing Procedures of a Business

Now that we have closed the temporary accounts, let’s review what the post-closing ledger (T-accounts) looks like for Printing Plus. 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. Closing journal entries are made at the end of an accounting period to prepare the accounting records for the next period. They zero-out the balances of temporary accounts during the current period to come up with fresh slates for the transactions in the next period. We see from the adjusted trial balance that our revenue accounts have a credit balance.

• As mentioned, temporary accounts in the general ledger consist of income statement accounts such as sales or expense accounts.
• It is important to understand retained earnings is not closed out, it is only updated.
• We also have an accompanying spreadsheet which shows you an example of each step.
• Examples of temporary accounts include revenue, expense and dividends paid accounts.

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. The second entry requires expense accounts close to the Income Summary account. https://simple-accounting.org/closing-entries-how-to-prepare/ To get a zero balance in an expense account, the entry will show a credit to expenses and a debit to Income Summary. Printing Plus has $100 of supplies expense, $75 of depreciation expense–equipment, $5,100 of salaries expense, and $300 of utility expense, each with a debit balance on the adjusted trial balance.

The closing entry will credit Supplies Expense, Depreciation Expense–Equipment, Salaries Expense, and Utility Expense, and debit Income Summary. You might be asking yourself, https://simple-accounting.org/ “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?

There are a few things to keep in mind when preparing closing entries. If the balances are correct, then you have verified the accuracy of the closing entries. BE3-13 (L08) Assume that Best Buy made a December 31 adjusting entry to debit Salaries and Wages Expense and credit Salaries and Wages Payable for $4,200 for one of its departments. Prepare Best Buy’s (a) January 1 reversing entry; (b) January 2 entry (assuming the reversing entry was prepared); and (c) January 2 entry (assuming the reversing entry was not prepared).

Close Income Summary

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. 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.

• The closing entry will credit Supplies Expense, Depreciation Expense–Equipment, Salaries Expense, and Utility Expense, and debit Income Summary.
• In it, the account balances for temporary accounts can be found and used to prepare the closing entries.
• The balance in the asset account is the same as the balance in the revenue account.
• When a company’s fiscal year comes to a close, it must prepare closing entries in the general ledger.
• Consider the following example for a better understanding of closing entries.
• Temporary accounts are accounts in the general ledger that are used to accumulate transactions over a single accounting period.
• Balances from temporary accounts are shifted to the income summary account first to leave an audit trail for accountants to follow.