Closing Entries: Step by Step Guide

Closing entries are the journal entries used at the end of an accounting period. GJ-2 simply means these entries were made on the second page of the general journal and posted to the general ledger above. Similarly, the accounts listed on the general journal under the “Reference” column indicate the accounting entries were posted to the respective general ledger accounts to close the accounts for January. HighRadius Autonomous Accounting Application consists of End-to-end Financial Close Automation, AI-powered Anomaly Detection and Account Reconciliation, and Connected Workspaces. Delivered as SaaS, our solutions seamlessly integrate bi-directionally with multiple systems including ERPs, HR, CRM, Payroll, and banks.

Adjusting entries ensure that revenues and expenses are appropriately recognized in the correct accounting period. 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. This process resets both the income and expense accounts to zero, preparing them for the next accounting period.

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 what is inventory period, which is an application of the time period assumption. Now that all the temporary accounts are closed, the income summary account should have a balance equal to the net income shown on Paul’s income statement.

Close expense accounts

Temporary accounts include all revenue and expense accounts, and also withdrawal accounts of owner/s in the case of sole proprietorships and partnerships (dividends for corporations). These entries are made to update retained earnings to reflect the results of operations and to eliminate the balances in the revenue and expense accounts, enabling them to be used again in a subsequent period. Let’s say your business wants to create month-end closing entries. During the accounting period, you earned $5,000 in revenue and had $2,500 in expenses.

• Temporary accounts include revenue, expenses, and dividends, and these accounts must be closed at the end of the accounting year.
• In essence, we are updating the capital balance and resetting all temporary account balances.
• The purpose of this entry is to zero out all temporary accounts so that they are ready to be used in the next accounting period.
• Any remaining balances will now be transferred and a post-closing trial balance will be reviewed.

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. 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. Clear the balance of the expense accounts by debiting income summary and crediting the corresponding expenses.

What are the transactions made at the end of an accounting period?

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. After preparing the closing entries above, Service Revenue will now be zero. The expense accounts and withdrawal account will now also be zero. There are 4 closing entries done at the end of the accounting cycle.

By debiting the revenue account and crediting the dividend and expense accounts, the balance of $3,450,000 is credited to retained earnings. 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.

Accounting Simplified

Any remaining balances will now be transferred and a post-closing trial balance will be reviewed. The Income Summary balance is ultimately closed to the capital account. They are special entries posted at the end of an accounting period. The completion of these steps finalizes the process of making closing entries.

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Close Expense Accounts

This will ensure that the balances of the revenue account are transferred to the income summary account. 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. It can directly be closed in the retained earnings account or it can be done through a longer process.

The second entry closes expense accounts to the Income Summary account. The third entry closes the Income Summary account to Retained Earnings. The fourth entry closes the Dividends account to Retained Earnings. The information needed to prepare closing entries comes from the adjusted trial balance. 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. As mentioned, temporary accounts in the general ledger consist of income statement accounts such as sales or expense accounts.

In next accounting period, these temporary accounts are opened again which normally start with a zero balance. In a general financial accounting system, temporary or nominal accounts include revenue, expense, dividend and income summary accounts. Closing journal entries are exceptional because, unlike most journal entries, there are no transactions taking place. This means that whatever the normal balance for any given account is, it will be zeroed out by an opposing entry. Thus, if the normal balance is a debit, then a credit will be taken, if the normal balance is a credit, then a debit will be taken. Temporary (nominal) accounts are accounts that are closed at the end of each accounting period, and include income statement, dividends, and income summary accounts.

Net income directly increases retained earnings and owner’s equity, or the value of the business as discussed in accounting formulas and net income. The $248 transferred to retained earnings appears on the balance sheet template for January. The income summary account balance depends on whether or not the business in question earns or loses money during the accounting period being closed. Before making closing entries, an accountant must run a trial balance, which will provide all of the information necessary to make closing entries. A trial balance is a report that can be run to verify that the total debits for an accounting period equal the total credits for the same. In it, the account balances for temporary accounts can be found and used to prepare the closing entries.

The $10,000 of revenue generated through the accounting period will be shifted to the income summary account. Remember that all revenue, sales, income, and gain accounts are closed in this entry. The income summary is a temporary account used to make closing entries. To close that, we debit Service Revenue for the full amount and credit Income Summary for the same. Dividend account is credited to record the closing entry for dividends. The difference between sales and expenses, or net income, was transferred to the income summary account.

You begin the closing process by transferring revenue and expense account balances to the income summary account, a temporary account used specifically to transfer revenue and expense account balances. If income summary account has a credit balance, it means the business has earned a profit during the period and increased its retained earnings. The income summary account is, therefore, closed by debiting income summary account and crediting retained earnings account. The permanent account to which the balances of all temporary accounts are closed is the retained earnings account in case of a company and owner’s capital account in case of a sole proprietorship. The first entry closes revenue accounts to the Income Summary account.

Process of preparing closing entries

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. The retained earnings account is reduced by the amount paid out in dividends through a debit, and the dividends expense is credited. Once this is done, it is then credited to the business’s retained earnings. A business will use closing entries in order to reset the balance of temporary accounts to zero. At the end of the year, all the temporary accounts must be closed or reset, so the beginning of the following year will have a clean balance to start with.

If your expenses for December had exceeded your revenue, you would have a net loss. When closing expenses, you should list them individually as they appear in the trial balance. The T-account summary for Printing Plus after closing entries are journalized is presented in Figure 1.31. 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 the following Figure 1.28. It is the end of the year, December 31, 2018, and you are reviewing your financials for the entire year.