Closing Entries: Definition, Types, and Examples

So, revenue, expense, gain, and loss accounts are all closed at the end of a period to retained earnings (for corporations), member’s capital accounts (for partnerships), or an income summary account. The income summary account is also a temporary account that is closed out at the end of the period. Closing entries are journal entries used to empty temporary accounts at the end of a reporting period and transfer their balances into permanent accounts. Temporary accounts are used to accumulate income statement activity during a reporting period.

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. 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. 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.

As mentioned, temporary accounts in the general ledger consist of income statement accounts such as sales or expense accounts. When the income statement is published at the end of the year, the balances of these accounts are transferred to the income summary, which is also a temporary account. Closing entries is the step before preparing the post-closing trial balance, which consists temporary accounts only like assets, liabilities, and equity accounts. In this step, the company prepares journal entries that would make the temporary accounts have zero balances. We see from the adjusted trial balance that our revenue accounts have a credit balance. To make them zero we want to decrease the balance or do the opposite.

Movement on the Retained Earnings Account

Retained earnings represent the amount your business owns after paying expenses and dividends for a specific time period. When dividends are declared by corporations, they are usually recorded by debiting Dividends Payable and crediting Retained Earnings. Note that by doing this, it is already deducted from Retained Earnings (a capital account), hence will not require a closing entry. To close the drawing account to the capital account, we credit the drawing account and debit the capital account. Close the income summary account by debiting income summary and crediting retained earnings. Permanent accounts are accounts that show the long-standing financial position of a company.

The closing entries are the journal entry form of the Statement of Retained Earnings. The goal is to make the posted balance of the retained earnings account match what we reported on the statement of retained earnings and start the next period with a zero balance for all temporary accounts. 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.

Trial Balance

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. To update the balance in the owner’s capital account, accountants close revenue, expense, and drawing accounts at the end of each fiscal year or, occasionally, at the end of each accounting period. For this reason, these types of accounts are called temporary or nominal accounts.

• We do not need to show accounts with zero balances on the trial balances.
• Permanent accounts are accounts that show the long-standing financial position of a company.
• In a sole proprietorship, a drawing account is maintained to record all withdrawals made by the owner.
• In partnerships, a compound entry transfers each partner’s share of net income or loss to their own capital account.
• The income summary account is also a temporary account that is closed out at the end of the period.

By doing so, the company moves these balances into permanent accounts on the balance sheet. These permanent accounts show a company’s long-standing financials. 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. The retained earnings account balance has now increased to 8,000, and forms part of the trial balance after the closing journal entries have been made.

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. However, predetermined overhead rate 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.

Step #1: Close Revenue Accounts

This trial balance gives the opening balances for the next accounting period, and contains only balance sheet accounts including the new balance on the retained earnings account as shown below. It is permanent because it is not closed at the end of each accounting period. At the start of the new accounting period, the closing balance from the previous accounting period is brought forward and becomes the new opening balance on the account. Other than the retained earnings account, closing journal entries do not affect permanent accounts. A sole proprietor or partnership often uses a separate drawings account to record withdrawals of cash by the owners.

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. If a company’s revenues are greater than its expenses, the closing entry entails debiting income summary and crediting retained earnings. In the event of a loss for the period, the income summary account needs to be credited and retained earnings reduced through a debit.

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. The income summary is used to transfer the balances of temporary accounts to retained earnings, which is a permanent account on the balance sheet.

• This is done through a journal entry that debits revenue accounts and credits the income summary.
• As part of the closing entry process, the net income (NI) is moved into retained earnings on the balance sheet.
• Closing entries are journal entries used to empty temporary accounts at the end of a reporting period and transfer their balances into permanent accounts.
• However, your business is also free to handle closing entries monthly, quarterly, or every six months.
• Afterwards, withdrawal or dividend accounts are also closed to the capital account.

Failing to make a closing entry, or avoiding the closing process altogether, can cause a misreporting of the current period’s retained earnings. It can also create errors and financial mistakes in both the current and upcoming financial reports, of the next accounting period. Expense accounts have a debit balance, so you’ll have to credit their respective balances and debit income summary in order to close them. As mentioned, one way to make closing entries is by directly closing the temporary balances to the equity or retained earnings account. In essence, we are updating the capital balance and resetting all temporary account balances. This is closed by doing the opposite – debit the capital account (decreasing the capital balance) and credit Income Summary.

Example of Closing Entries

Clear the balance of the revenue account by debiting revenue and crediting income summary. 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). This time period, called the accounting period, usually reflects one fiscal year.

Notice that the effect of this closing journal entry is to credit the retained earnings account with the amount of 1,400 representing the net income (revenue – expenses) of the business for the accounting period. Learn how to write closing journal entries for revenue, expense, and dividend accounts. Instead, the basic closing step is to access an option in the software to close the reporting period. Doing so automatically populates the retained earnings account for you, and prevents any further transactions from being recorded in the system for the period that has been closed. The expense accounts have debit balances so to get rid of their balances we will do the opposite or credit the accounts.

The purpose of the closing entry is to reset the temporary account balances to zero on the general ledger, the record-keeping system for a company’s financial data. After the closing journal entry, the balance on the drawings account is zero, and the capital account has been reduced by 1,300. After the closing entry is made, Bill’s balance sheet would list $8,000 of assets, https://online-accounting.net/ $3,000 of liabilities, and $5,000 of equity. These ending balances will carry forward and become the beginning balances in the next period. The income and expenses accounts, on the other hand, will have a zero ending balance and will start the next year with a zero balance. The purpose of closing entries is to merge your accounts so you can determine your retained earnings.

These accounts carry forward their balances throughout multiple accounting periods. Temporary accounts are accounts in the general ledger that are used to accumulate transactions over a single accounting period. The balances of these accounts are eventually used to construct the income statement at the end of the fiscal year. Temporary account balances can either be shifted directly to the retained earnings account or to an intermediate account known as the income summary account beforehand. Closing entries, on the other hand, are entries that close temporary ledger accounts and transfer their balances to permanent accounts. After the posting of this closing entry, the income summary now has a credit balance of $14,750 ($70,400 credit posted minus the $55,650 debit posted).

The Income Summary balance is ultimately closed to the capital account. The process of using of the income summary account is shown in the diagram below. You can close your books, manage your accounting cycle, issue invoices, pay back vendor bills, and so much more, from any device with an internet connection, just by downloading the Deskera mobile app. Lastly, if we’re dealing with a company that distributes dividends, we have to transfer these dividends directly to retained earnings. In other words, they represent the long-standing finances of your business. Notice that the balance of the Income Summary account is actually the net income for the period.