What are your total expenses for
rent, electricity, cable and internet, gas, and food for the
current year? You have also not incurred any expenses yet for rent,
electricity, cable, internet, gas or food. 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. A net loss would decrease retained earnings so we
would do the opposite in this journal entry by debiting Retained
Earnings and crediting Income Summary.
One of the most important steps in the accounting cycle is creating and posting your closing entries. To close expenses, we simply credit the expense accounts and debit Income Summary. To close that, we debit Service Revenue for the full amount and credit Income Summary for the same. The income summary is a temporary account used to make closing entries. Now, it’s time to close the income summary to the retained earnings (since we’re dealing with a company, not a small business or sole proprietorship).
- All of Paul’s revenue or income accounts are debited and credited to the income summary account.
- The fourth entry requires Dividends to close to the Retained
Earnings account. - These accounts carry forward their balances throughout multiple accounting periods.
- The $1,000 net profit balance generated through the accounting period then shifts.
- The main change from an adjusted trial balance is revenues, expenses, and dividends are all zero and their balances have been rolled into retained earnings.
This is the same figure found on the statement of retained earnings. 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.
Step #1: Close Revenue Accounts
For our purposes, assume that we are closing the books at the
end of each month unless otherwise noted. Closing entries are an important facet of keeping your business’s books and records in order. By maintaining your bookkeeping, you can ensure that you are constantly kept informed. As well as being consistently up-to-date on the financial health of your business.
You see that you earned $120,000 this year in revenue and had expenses for rent, electricity, cable, internet, gas, and food that totaled $70,000. We have completed the first two columns and now we have the final column which represents the closing (or archive) process. For partnerships, each partners’ capital account will be credited based on the agreement of the partnership (for example, 50% to Partner A, 30% to B, and 20% to C).
- All modern accounting software automatically generates closing entries, so these entries are no longer required of the accountant; it is usually not even apparent that these entries are being made.
- Essentially resetting the account balances to zero on the general ledger.
- This is the same figure found on the statement of
retained earnings. - The main purpose of these closing entries is to bring the temporary journal account balances to zero for the next accounting period, which keeps the accounts reconciled.
- Notice that revenues, expenses, dividends, and income summary all have zero balances.
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 bank guarantee vs letter of credit across periods, particularly with income. 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 period, which is an application of the time period assumption.
Recording a Closing Entry
Just like in step 1, we will use Income Summary as the offset account but this time we will debit income summary. The total debit to income summary should match total expenses from the income statement. 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. There may be a scenario where a business’s revenues are greater than its expenses.
We do not need to show accounts with zero
balances on the trial balances. The closing entries are the journal entry form
of the Statement of Retained Earnings. 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. Revenue and expense accounts are closed to Income Summary, and Income Summary and Dividends are closed to the permanent account, Retained Earnings.
Are the value of your assets and
liabilities now zero because of the start of a new year? Your car,
electronics, and furniture did not suddenly lose all their value,
and unfortunately, you still have outstanding debt. 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.
In just a few clicks, the entire financial year closing is streamlined for you. Retained earnings are those earnings not distributed to shareholders as dividends, but retained for further investment, often in advertising, sales, production, and equipment. Now, if you’re new to accounting, you probably have a ton of questions.
What are the four closing entries in order?
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. All of these entries have emptied the revenue, expense, and income summary accounts, and shifted the net profit for the period to the retained earnings account. ‘Total expenses‘ account is credited to record the closing entry for expense accounts. On the statement of retained earnings, we reported the
ending balance of retained earnings to be $15,190.
The income statement
summarizes your income, as does income summary. 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. This is an optional step
in the accounting cycle that you will learn about in future
courses. Steps 1 through 4 were covered in
Analyzing and Recording Transactions and Steps 5 through 7
were covered in
The Adjustment Process. They are special entries posted at the end of an accounting period.
The Purpose of Closing Entries
Dividend account is credited to record the closing entry for dividends. These accounts are be zeroed and their balance should be transferred to permanent accounts. Remember that all revenue, sales, income, and gain accounts are closed in this entry. All modern accounting software automatically generates closing entries, so these entries are no longer required of the accountant; it is usually not even apparent that these entries are being made. Prepare the closing entries for Frasker Corp. using the adjusted trial balance provided. The income statement summarizes your income, as does income summary.
Closing Entry for Expense Account
The remaining balance in Retained Earnings is
$4,565 (Figure
5.6). This is the same figure found on the statement of
retained earnings. In addition, if the accounting system uses subledgers, it must close out each subledger for the month prior to closing the general ledger for the entire company.
Examples of Closing Entries
The balance sheet’s assets, liabilities, and owner’s equity accounts, however, are not closed. These permanent accounts and their ending balances act as the beginning balances for the next accounting period. If dividends were not declared, closing entries would cease at this point.