Closing Entry Definition, Explanation, and Examples

This transaction increases your capital account and zeros out the income summary account. Revenue is one of the four accounts that needs to be closed to the income summary account. This is the adjusted trial balance that will be used to make your closing entries. While these accounts remain on the books, their balance is reset to zero each month, which is done using closing entries. Prepare the closing entries for Frasker Corp. using the adjusted trial balance provided.

In accounting terms, these journal entries are termed as closing entries. 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. Then you are going to create a journal entry to transfer the balance of each temporary account to the appropriate permanent account. For example, the balance of a revenue account will go to the income summary. Once adjusting entries have been made, closing entries are used to reset temporary accounts and transfer their balances to permanent accounts.

It stores all of the closing information for revenues and expenses, resulting in a “summary” of income or loss for the period. The balance in the Income Summary account equals the net income or loss for the period. The accounts that need to start with a clean or $0 balance going into the next accounting period are revenue, income, and any dividends from January 2019. To determine the income (profit or loss) from the month of January, the store needs to close the income statement information from January 2019. Instead, the basic closing step is to access an option in the software to close the reporting period.

  1. Well, dividends are not part of the income statement because they are not considered an operating expense.
  2. A closing entry is provided for the closing of income-expenditure accounts.
  3. Suppose a business had the following trial balance before any closing journal entries at the end of an accounting period.
  4. The income statement reflects your net income for the month of December.
  5. By debiting the revenue account and crediting the dividend and expense accounts, the balance of $3,450,000 is credited to retained earnings.

To close the expense accounts for Bob, we need to debit the income summary account and credit all the relevant individual expenses accounts such as utilities expense, wages expense depreciation expense, etc. This will ensure that the balances of those expenses account are transferred to the income summary account. As mentioned earlier, this is just an intermediate account that is used to zero out all the other revenues and expenses accounts into one place. The balances of the income summary account will eventually also be transferred to the retained earnings account on the balance sheet.

Four Steps in Preparing Closing Entries

We’ll use a company called MacroAuto that creates and installs specialized exhaust systems for race cars. Here are MacroAuto’s accounting records simplified, using positive numbers for increases and negative numbers for decreases instead of debits and credits in order to save room and to get a higher-level view. If it all seems a bit complex or maybe you are a small business owner who takes on their own accounting, you may wonder if you really need to know closing entries in practice. The beautiful thing is that some accounting programs like QuickBooks, make these entries for you.

What is a closing entry?

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.

Revenue and expense accounts are closed to Income Summary, and Income Summary and Dividends are closed to the permanent account, Retained Earnings. A temporary account is an income statement account, dividend account or drawings account. At the end of the accounting period, the balance is transferred to the retained earnings account, and the account is closed with a zero balance. Temporary (nominal) accounts are accounts that are closed at the end of each accounting period, and include income statement, dividends, and income summary accounts. In the next accounting period, these temporary accounts are opened again, which normally start with a zero balance. In a general financial accounting system, temporary or nominal accounts include revenue, expense, dividend, and income summary accounts.

The Accounting Cycle Example

The income statement reflects your net income for the month of December. With the use of modern accounting software, this process often takes place automatically. The third entry requires Income Summary to close to the Retained Earnings account. To get a zero balance closing entries example in the Income Summary account, there are guidelines to consider. 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.

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, $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. The first entry requires revenue accounts close to the Income Summary account.

The Statement of Cash Flow shows Cash’s business transaction, whether its inflow or outflow. Dividends are paid by Cash, so the transaction balance of paid tips would be demonstrated under Financial Activities. Accrued Expenses are expenses from the previous fiscal year that still need to be paid.

This is no different from what will happen to a company at the end of an accounting period. A company will see its revenue and expense accounts set back to zero, but its assets and liabilities will maintain a balance. In summary, the accountant resets the temporary accounts to zero by transferring the balances to permanent accounts.

You will start by clearing out the income accounts from the income statement (revenue) and crediting the income summary. After the closing journal entry, the balance on the drawings account is zero, and the capital account has been reduced by 1,300. The purpose of the income summary is to show the net income (revenue less expenses) of the business in more detail before it becomes part of the retained earnings account balance. Once all of the required entries have been made, you can run your post-closing trial balance, as well as other reports such as an income statement or statement of retained earnings. The retained earnings account is reduced by the amount paid out in dividends through a debit, and the dividends expense is credited. Income summary is a holding account used to aggregate all income accounts except for dividend expenses.

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. 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.

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. It is important to understand retained earnings is not closed out, it is only updated. Closing your accounting books consists of making closing entries to transfer temporary account balances into the business’ permanent accounts. A closing entry is an accounting entry that is used to transfer the balances of temporary accounts to permanent accounts.

The company transfers temporary account balances to the permanent owner’s equity account, Owner’s Capital, using closing entries at the end of each accounting period. In order to close out your expense accounts, you will need to debit the income summary account, and credit each line item expense listed in the trial balance, which reduces the expense account balances to zero. You begin the closing process by transferring revenue and expense account balances to the income summary account, a temporary account used specifically to transfer revenue and expense account balances.