In accounting, bookkeepers and accountants often refer to the process of closing entries as closing the books. Closing entries accounting involves making closing journal entries at the end of accounting periods. This process transfers balances from temporary to permanent accounts, highlighting when closing entries are made for accurate financial reporting. In this part, we’ll take you through a comprehensive guide on closing entries.
What are Closing Entries?
Closing entries are journal entries made at the end of accounting periods that involve transferring data from temporary accounting on the temporary accounts on the income statement to permanent accounts.
Temporary accounts include revenue, expenses, and dividends. These accounts must be closed at the end of the accounting year. And closing entries accounting are used to reset the balances of temporary accounting to zero so they are ready for the next accounting period.
All income statement balances are eventually shifted to retained earnings, which is a permanent account on the balance sheet.
Permanent and Temporary Accounts
Temporary accounts, as mentioned above, including revenues, expenses, dividends or (withdrawal) accounts. These account balances are used to record accounting activity during a specific period and do not roll over into the next year. For example, $1000 in revenue this year is not recorded as $1000 of revenue for the next year, even though the company retained the money for use in the next 12 months.
Permanent accounts, on the other hand, include assets, liabilities, and most equity accounts. These account balances roll over into the next period and reflect the company's financial activity in the long term. They are stored on the balance sheet, a section of the financial statements that investors can use as an indication to asset a company’s value.
Income Summary Account
Income summary account is a temporary account used to make closing entries. All temporary accounts must be reset to zero at the end of the accounting period. In this way, the 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.
How to closing entries
First, all revenue accounts are transferred to the income summary by debiting the revenue accounts and crediting income summary. The credit to income summary must be equal to the total revenue from the income statement.
Second, just like step one, you need to clear the balance of the expense accounts by debiting income summary and crediting the corresponding expenses.
Next, you close the income summary by debiting income summary and crediting retained earnings.
Last, you close dividends accounts by debiting retained earnings and crediting dividends.
Closing entry sample
Below is an example of a closing entry that follows the four basic steps in the closing process as mentioned above:
Close expense accounts
Date | Accounts | Debit | Credit |
2021 | Revenue | $50,000 | |
Dec. 31 | Income Summary | | $50,000 |
Close income summary
Date | Accounts | Debit | Credit |
2021 | Income Summary | $42,500 | |
Dec. 31 | Cost of Goods Sold | | $12,000 |
| Depreciation expense | | $4,500 |
| Rent expense | | $4,000 |
| Interest expense | | $2,000 |
| Salaries expense | | $18,000 |
Close income summary
Date | Accounts | Debit | Credit |
2021 | Income Summary | $10,000 | |
Dec. 31 | Retained Earnings | | $10,000 |
Close dividends
Date | Accounts | Debit | Credit |
2021 | Retained Earnings | $2,000 | |
Dec. 31 | Dividends | | $2,000 |
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