Closing Entries Accounting 101

Each accounting period’s data must be contained within the designated time frame in order to accurately depict the financial standings of the company. The purpose of the income summary is to show the net income (revenue less expenses) of the business in more detail before it becomes part of the retained earnings account balance. ‘Total expenses‘ account is credited to record the closing entry for expense accounts. Now that the journal entries are prepared and posted, you are almost ready to start next year. Remember, modern computerized accounting systems go through this process in preparing financial statements, but the system does not actually create or post journal entries. If your business is a sole proprietorship or a partnership, your next step will be to close your income summary account.

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. However, if the company also wanted to keep year-to-date
information from month to month, a separate set of records could be
kept as the company progresses through the remaining months in the
year. For our purposes, assume that we are closing the books at the
end of each month unless otherwise noted. Then, making sure Dividends is paid to shareholders at the end of the fiscal year, the Dividends account would be credited, and Retained Earnings would be debited.

Essentially, all opening entries of a new fiscal year are the exact entries and figures of the previous period’s closing entries. Therefore, the beginning balance of these accounts can be taken from the previous period closing account balances. Our discussion here begins with journalizing and posting the
closing entries (Figure
5.2). These posted entries will then translate into a
post-closing trial balance, which is a trial
balance that is prepared after all of the closing entries have been
recorded. During the process of closing accounts, there are multiple steps and information that you must remember. If not followed precisely, it would cause a misreport of a very important Account.

As you can tell by the examples of Temporary Accounts, they all belong to 3 types of accounts. This is no different from what will happen to a company at the
end of an accounting period. A company will see its revenue and
expense accounts set back to zero, but its assets and liabilities
will maintain a balance. In summary, the accountant resets the
temporary accounts to zero by transferring the balances to
permanent accounts.

The expenses would be listed in the expense section, so you would need to find the total costs. Manual processes struggle to handle the increasing volume of financial transactions and complexities. Most organizations appear to be doing well on the surface while underlying accounting management issues silently sabotage. The Statement of Cash Flow shows Cash’s business transaction, whether its inflow or outflow.

When revenues exceed the expenses, the income summary account will be positive and will have a credit balance. The balance of the income summary account should tally with the net income as derived from the income statement. Temporary accounts record transactions for a single accounting cycle, and then they are closed. After the closing journal entry, the balance on the dividend account is zero, and the retained earnings account has been reduced by 200. We need to do the closing entries to make them match and zero out the temporary accounts. As part of the closing entry process, the net income (NI) is moved into retained earnings on the balance sheet.

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 first part is the date of
declaration, which creates the obligation or liability to pay the
dividend. The second part is the date of record that determines who
receives the dividends, and the third part is the date of payment,
which is the date that payments are made. Printing Plus has $100 of
dividends with a debit balance on the adjusted trial balance. Notice that the balances in the expense accounts are now zero
and are ready to accumulate expenses in the next period.

  1. An example would be if the company were to get sued, then a lawyer would be hired, and that fee would need to be paid.
  2. Closing entries are journal entries posted at the end of an accounting period to reset temporary accounts to zero and transfer their balances to a permanent account known as retained earnings.
  3. Income and expenses are closed to a temporary clearing account, usually Income Summary.
  4. The net result of these activities is to move the net profit or net loss for the period into the retained earnings account, which appears in the stockholders’ equity section of the balance sheet.

In this chapter, we complete the final steps (steps 8 and 9) of
the accounting cycle, the closing process. 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. Notice how only the balance in retained earnings has changed and it now matches what was reported as ending retained earnings in the statement of retained earnings and the balance sheet. 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.

Step 4: Close withdrawals to the capital 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. 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.

Closing Entry Definition, Explanation, and Examples

An example would be if the company were to get sued, then a lawyer would be hired, and that fee would need to be paid. Preparing for Closing Entry is simple and quick, as all the required information can be easily found. Closing Entries are designed qbse android after Financial Statements for the fiscal periods are created, which means all the needed information is already there; you need to find it. An accounting year-end which is not the calendar year end is sometimes referred to as a fiscal year end.

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. If both summarize
your income in the same period, then they must be equal. After Closing Entries in the accounting cycle, a Post-Closing Trial Balance would be created. Just like a normal Trial Balance, it will contain and display all accounts that have non-zero balances and see if the debits and credits will balance. 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.

Closing Journal Entries in Accounting Ledgers

That way, your next accounting period does not have a balance in your revenue or expense account from the previous period. 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. 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. We see from the adjusted trial balance that our revenue accounts have a credit balance.

Dividend account is credited to record the closing entry for dividends. The general journal is used to record various types of accounting entries, including closing entries at the end of an accounting period. The general ledger is the central repository of all accounts and their balances, including the closing entries. The trial balance is like a snapshot of your business’s financial health at a specific moment. In this case, since it’s an opening trial balance, we’re just getting started with the accounting cycle (Step 1).

Record To Report

The next day, January 1, 2019, you get ready for work, but
before you go to the office, you decide to review your financials
for 2019. What are your total expenses for
rent, electricity, cable and internet, gas, and food for the
current year? You have also not incurred any expenses yet for rent,
electricity, cable, internet, gas or food. This means that the
current balance of these accounts is zero, because they were closed
on December 31, 2018, to complete the annual accounting 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. In Accounting, Closing Entries are the same in every accounting standard worldwide except for some minor details.

Let’s move on to learn about how to record closing those temporary accounts. Since we credited income summary in Step 1 for $5,300 and debited income summary for $5,050 in Step 2, the balance in the income summary account is now a credit of $250. Clear the balance of the revenue account by debiting revenue and crediting income summary. The
business has been operating for several years but does not have the
resources for accounting software. This means you are preparing all
steps in the accounting cycle by hand. When closing entries, those three types of accounts are the only ones closed.

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. These accounts are be zeroed and their balance should be transferred to permanent accounts.

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