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. To further clarify this concept, balances are closed to assure all revenues and expenses are recorded in the proper period and then start over the following period. 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.

Accountants may perform the closing process monthly or annually. The closing entries are the journal entry form of the Statement of Retained Earnings. 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. Assume Bill’s Brewery earns $10,000 of income for the year and has $5,000 of expenses. Closing entries prepare a company for the next
accounting period by clearing any outstanding balances in certain
accounts that should not transfer over to the next period.

Closing Entries Accounting with Automation

The first entry requires revenue accounts close to the Income
Summary account. To get a zero balance in a revenue account, the
entry will show a debit to revenues and a credit to Income Summary. Printing Plus has $140 what is variance analysis 2021 definition examples andadvantages of interest revenue and $10,100 of service
revenue, each with a credit balance on the adjusted trial balance. The closing entry will debit both interest revenue and service
revenue, and credit Income Summary.

  • 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.
  • All of Paul’s revenue or income accounts are debited and credited to the income summary account.
  • The T-account summary for Printing Plus after closing entries are journalized is presented in Figure 5.7.
  • The total of the income summary account after the all temporary accounts have been close should be equal to the net income for the period.
  • 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.

It can also create errors and financial mistakes in both the current and upcoming financial reports, of the next accounting period. As mentioned, one way to make closing entries is by directly closing the temporary balances to the equity or retained earnings account. Accounts are considered “temporary” when they only accumulate transactions over one single accounting period. Temporary accounts are closed or zero-ed out so that their balances don’t get mixed up with those of the next year.

Close all expense and loss accounts

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.

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All expense accounts are then closed to the income summary account by crediting the expense accounts and debiting income summary. Closing all temporary accounts to the retained earnings account is faster than using the income summary account method because it saves a step. There is no need to close temporary accounts to another temporary account (income summary account) in order to then close that again. 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. If your business is a sole proprietorship or a partnership, your next step will be to close your income summary account. You can do this by debiting the income summary account and crediting your capital account in the amount of $250.

How to Post Closing Entries

This resets the income accounts to zero and prepares them for the next year. The $9,000 of expenses generated through the accounting period will be shifted from the income summary to the expense account. In this example, the business will have made $10,000 in revenue over the accounting period. In this example, it is assumed that there is just one expense 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.

Types of Accounts

Notice that the Income Summary account is now zero and is ready
for use in the next period. The Retained Earnings account balance
is currently a credit of $4,665. 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.

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. 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. All temporary accounts must be reset to zero at the end of the accounting period. To do this, their balances are emptied into the income summary account. The income summary account then transfers the net balance of all the temporary accounts to retained earnings, which is a permanent account on the balance sheet. Companies use closing entries to reset the balances of temporary accounts − accounts that show balances over a single accounting period − to zero.

These accounts carry forward their balances throughout multiple accounting periods. However, some corporations use a temporary clearing account for dividends declared (let’s use “Dividends”). They’d record declarations by debiting Dividends Payable and crediting Dividends. If this is the case, then this temporary dividends account needs to be closed at the end of the period to the capital account, Retained Earnings.

This process resets both the income and expense accounts to zero, preparing them for the next accounting period. These accounts have continuous balances that carry forward from one accounting period to another. Examples of accounts not affected by closing entries include asset, liability, and equity accounts. Only income
statement accounts help us summarize income, so only income
statement accounts should go into income summary. 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.

Manual processes struggle to handle the increasing volume of financial transactions and complexities. All accounts can be classified as either permanent (real) or
temporary (nominal) (Figure
5.3). Answer the following questions on closing entries and rate your confidence to check your answer.