A closing entry is a journal entry made at the end of accounting periods that involves shifting data from temporary accounts on the income statement to permanent accounts on the balance sheet. Temporary accounts include revenue, expenses, and dividends, and these accounts must be closed at the end of the accounting year. The temporary accounts get closed at the end of an accounting year. Since the temporary accounts are closed at the end of each fiscal year, they will begin the new fiscal year with zero balances. 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 period and are set back to zero when the period ends.
The income summary is a temporary account of the company where the revenues and expenses were transferred to. After the other two accounts are closed, the net income is reflected. Taking the example above, total revenues of $20,000 minus total expenses of $5,000 gives a net income of $15,000 as reflected in the income summary. The statement of retained earnings shows the period-ending retained earnings after the closing entries have been posted.
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. Drawing or withdrawal accounts of the owner/s in sole proprietorships and partnerships.
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. Example – As of 31st March, YYYY if the ABC and Co. had Cash at Bank amounting to 2,50,000, then that amount will be carried forward (c/f) as opening bank balance in next accounting year. If the bank balance increased by 2,00,000, then at the end of the accounting year Cash at Bank would become 4,50,000. This amount will be again c/f onto the next accounting period and the cycle keeps going. Asset accounts – asset accounts such as Cash, Accounts Receivable, Inventories, Prepaid Expenses, Furniture and Fixtures, etc. are all permanent accounts. Contra-asset accounts such as Allowance for Bad Debts and Accumulated Depreciation are also permanent accounts.
Accounts that do not get closed at the year-end
The second entry requires expense accounts close to the Income Summary account. 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, whitepapers on accounting & cloud technology $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.
Income and expenses are closed to a temporary clearing account, usually Income Summary. Afterwards, withdrawal or dividend accounts are also closed to the capital account. To close the drawing account to the capital account, we credit the drawing account and debit the capital account. Take note that closing entries are prepared only for temporary accounts. For example, ABC company was able to make $500,000 sales in 2020. If the sales account was not closed, it will be carried over to the next accounting period.
The accountant then needs to make a debit of $5,000 from the drawings account and a credit of the same amount to the capital account. 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. Below are the T accounts with the journal entries already posted. Basically, to close a temporary account is to close all accounts under the category. The T-account summary for Printing Plus after closing entries are journalized is presented in Figure 5.7.
If the 2020 account was not closed, the balance that would appear at the end of 2021 would be $1,100,000. But we want to measure what occurred in 2021 only, hence the need to close the the previous period’s balance. Expenses are an important part of any business because they keep the company going. The expense accounts are temporary accounts that show everything that the company spent on its operations, including advertising and supplies, among other expenses.
- Temporary accounts refer to accounts that are closed at the end of every accounting period.
- Asset accounts – asset accounts such as Cash, Accounts Receivable, Inventories, Prepaid Expenses, Furniture and Fixtures, etc. are all permanent accounts.
- Companies use closing entries to reset the balances of temporary accounts − accounts that show balances over a single accounting period − to zero.
- 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.
- For corporations, Income Summary is closed entirely to “Retained Earnings”.
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. 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.
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In a sole proprietorship, a drawing account is maintained to record all withdrawals made by the owner. In a partnership, a drawing account is maintained for each partner. All drawing accounts are closed to the respective capital accounts at the end of the accounting period. 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).
What are Temporary Accounts?
Once the year-end processing has been completed, all of the temporary accounts have been emptied and therefore “closed” for the current fiscal year. A flag in the accounting software is then set to close down the old fiscal year, which means that no one can enter transactions during that time period. At the end of the fiscal year, closing entries are used to shift the entire balance in every temporary account into retained earnings, which is a permanent account. The net amount of the balances shifted constitutes the gain or loss that the company earned during the period. Temporary accounts refer to accounts that are closed at the end of every accounting period. These accounts include revenue, expense, and withdrawal accounts.
The Accounting Cycle And Closing Process
When you compare the retained earnings ledger (T-account) to the statement of retained earnings, the figures must match. It is important to understand retained earnings is not closed out, it is only updated. Retained Earnings is the only account that appears in the closing entries that does not close. You should recall from your previous material that retained earnings are the earnings retained by the company over time—not cash flow but earnings. Now that we have closed the temporary accounts, let’s review what the post-closing ledger (T-accounts) looks like for Printing Plus.
Temporary AccountsWhat are temporary accounts?
The information needed to prepare closing entries comes from the adjusted trial balance. 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, or clearing the balances, means returning the account to a zero balance. Having a zero balance in these accounts is important so a company can compare performance across periods, particularly with income.
One more step…
If both summarize your income in the same period, then they must be equal. 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.
Any funds that are not held onto incur an expense that reduces NI. One such expense that is determined at the end of the year is dividends. The last closing entry reduces the amount retained by the amount paid out to investors. 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?
” Could we just close out revenues and expenses directly into retained earnings and not have this extra temporary account? 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.