What are Closing Entries? Definition Meaning Example

If a corporation has more than one class of stock and uses dividend accounts to record dividend payments to investors, it usually uses a separate dividend account for each class. If this is the case, the corporation’s accounting department makes a compound entry to close each dividend account to the retained earnings account. Here you will focus on debiting all of your business’s revenue accounts. After this closing entry has been posted, each of these revenue accounts has a zero balance, whereas the Income Summary has a credit balance of $7,400. In this example we will close Paul’s Guitar Shop, Inc.’s temporary accounts using the income summary account method from his financial statements in the previous example. On the statement of retained earnings, we reported the ending balance of retained earnings to be $15,190.

After most of the cycle is completed and financial statements are generated, there’s one last step in the process known as closing your books. And so, the amounts in one accounting period should be closed so that they won’t get mixed with those in the next period. QuickBooks Desktop doesn’t have an actual transaction for closing entries it automatically creates.

How, when and why do you prepare closing entries?

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. The remaining balance in Retained Earnings is $4,565 (Figure 5.6). This is the same figure found on the statement of retained earnings.

  • Below are examples of closing entries that zero the temporary accounts in the income statement and transfer the balances to the permanent retained earnings account.
  • Temporary accounts are used to accumulate income statement activity during a reporting period.
  • Closing entries are an important facet of keeping your business’s books and records in order.
  • The Income
    Summary account has a new credit balance of $4,665, which is the
    difference between revenues and expenses (Figure
  • From the Deskera “Financial Year Closing” tab, you can easily choose the duration of your accounting closing period and the type of permanent account you’ll be closing your books to.

Steps 1 through 4 were covered in Analyzing and Recording Transactions and Steps 5 through 7 were covered in The Adjustment Process. In a computerized accounting system, the closing entries are likely done electronically by simply selecting “Closing Entries” or by specifying the beginning and ending dates of the financial statements. As a result, the temporary accounts will begin the following accounting year with zero balances. Do you want to learn more about debit, credit entries, and how to record your journal entries properly?

Module 4: Completing the Accounting Cycle

In other words, the temporary accounts are closed or reset at the end of the year. 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.

Four Steps in Preparing Closing Entries

Now Paul must close the income summary account to retained earnings in the next step of the closing entries. The statement of retained earnings shows the period-ending retained earnings after the closing entries have been posted. When you compare the retained earnings ledger (T-account) to the statement of retained earnings, the figures must match. You should recall from your previous material that retained earnings are the earnings retained by the company over time—not cash flow but earnings.

Accounting Business and Society

Only permanent account balances should appear on the post-closing trial balance. These balances in post-closing T-accounts are transferred over to either the debit or credit column on the post-closing trial balance. When all accounts have been recorded, total each column and verify the columns equal each other. The statement of retained earnings shows the period-ending
retained earnings after the closing entries have been posted.

Closing entries Closing procedure

Revenue and expense accounts are closed to Income Summary, and Income Summary and Dividends are closed to the permanent account, Retained Earnings. 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.

Let’s explore each entry in more detail using Printing Plus’s
information from
Analyzing and Recording Transactions and
The Adjustment Process as our example. The Printing Plus
adjusted trial balance for January 31, 2019, is presented in

Figure 5.4. 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.

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. Other accounting software, such as Oracle’s PeopleSoft™, post closing entries to a special accounting period that keeps them separate from all of the other entries. 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. In a partnership, separate entries are made to close each partner’s drawing account to his or her own capital account.

Visit the website and take a quiz on accounting basics to test your knowledge. If you’re using the wrong credit or debit card, it could be costing you serious money. Our experts love this top pick, which features a 0% intro APR for 15 months, an insane cash back rate of up to 5%, and all somehow for no annual fee. Closing entry to account for draws taken for the month, for sole proprietors and partnerships. Then, just pick the specific date and year you want the closing process to take place, and you’re done!

The income summary account doesn’t factor in when preparing financial statements because its only purpose is to be used during the closing process. Temporary (nominal) accounts are accounts that
are closed at the end of each accounting period, and include income
statement, dividends, and income summary accounts. These accounts are
temporary because they keep their balances during the current
accounting how is the balance sheet prepared from trial balance period and are set back to zero when the period ends. Revenue and expense accounts are closed to Income Summary, and
Income Summary and Dividends are closed to the permanent account,
Retained Earnings. Closing entries, also called closing journal entries, are entries made at the end of an accounting period to zero out all temporary accounts and transfer their balances to permanent accounts.

Notice that the balances in interest revenue and service revenue are now zero and are ready to accumulate revenues in the next period. The Income Summary account has a credit balance of $10,240 (the revenue sum). Our discussion here begins with journalizing and posting the closing entries (Figure 5.2). Closing entries transfer the balances from the temporary accounts to a permanent or real account at the end of the accounting year. Failing to make a closing entry, or avoiding the closing process altogether, can cause a misreporting of the current period’s retained earnings. It can also create errors and financial mistakes in both the current and upcoming financial reports, of the next accounting period.

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. 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. The $10,000 of revenue generated through the accounting period will be shifted to the income summary account.

Leave a Comment