3 4 Purpose of the closing process and prepare closing entries Accounting Business and Society

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. Keep in mind, however, that this account is only purposeful for closing the books, and thus, it is not recorded into any accounting reports and has a zero balance at the end of the closing process. Thus, the income summary temporarily holds only revenue and expense balances. As you will see later, Income Summary is eventually closed to capital.

Companies generally journalize and post-closing entries only at the end of the annual accounting period, in contrast to the steps in the cycle. All of Paul’s revenue or income accounts are debited and credited to the income summary account. This resets the income accounts to zero and prepares them for the next year. Notice that the balances in interest revenue and service revenue are now zero and are ready to accumulate revenues in the next period. The Income Summary account has a credit balance of $10,240 (the revenue sum).

While these accounts remain on the books, their balance is reset to zero each month, which is done using closing entries. Do you want to learn more about debit, credit entries, and how to record your journal entries properly? Then, head over to our guide on journalizing transactions, with definitions and examples for business. Any account listed on the balance sheet, barring paid dividends, is a permanent account. On the balance sheet, $75 of cash held today is still valued at $75 next year, even if it is not spent.

• Prepare the closing entries for Frasker Corp. using the adjusted trial balance provided.
• When closing expenses, you should list them individually as they appear in the trial balance.
• However, the cash balances, as well as the other balance sheet accounts, are carried over from the end of a current period to the beginning of the next period.
• The fourth entry closes the Dividends account to Retained Earnings.

The $9,000 of expenses generated through the accounting period will be shifted from the income summary to the expense account. In this example, the business will have made $10,000 in revenue over the accounting period. In this example, it is assumed that there is just one expense account. The general journal is used to record various types of accounting entries, including closing entries at the end of an accounting period. These permanent accounts form the foundation of your business’s balance sheet. The trial balance is like a snapshot of your business’s financial health at a specific moment.

If your business is a sole proprietorship or a partnership, your next step will be to close your income summary account. You can do this by debiting the income summary account and crediting your capital account in the amount of $250. This reflects your net income for the month, and increases your capital account by $250. Both closing entries are acceptable and both result in the same outcome.

Step 3: Close Income Summary to the appropriate capital account

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. 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 where’s my refund earnings reduced through a debit. One account you’ll want to be aware of when performing closing entries is the income summary account. The income summary account is a temporary account that you put all revenue and expense accounts into at the end of the accounting period. First, revenue, expense and dividend accounts are temporary accounts, which means they accumulate balances only for the current accounting period.

The statement of change in equity shows the period-ending retained earnings after the closing entries have been posted. 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. 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. Closing entries, also called closing journal entries, are entries made at the end of an accounting period to zero out all temporary accounts and transfer their balances to permanent accounts.

To determine the income (profit or loss) from the month of January, the store needs to close the income statement information from January 2019. All revenue accounts will be zero after debiting the revenue account and crediting the income summary account, and the revenue account will be closed at the same time. Second, the closing process updates the retained earnings account to its correct end of period balance. Recall that the balance in the retained earnings comes from the statement of change in equity and not the adjusted trial balance.

Automating accounting management to increase projection velocity

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. As mentioned, one way to make closing entries is by directly closing the temporary balances to the equity or retained earnings account.

Chapter 3: Completion of the Accounting Cycle

The Printing Plus adjusted trial balance for January 31, 2019, is presented in Figure 5.4. 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. For our purposes, assume that we are closing the books at the end of each month unless otherwise noted.

Accounting Business and Society

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. The retained earnings account is reduced by the amount paid out in dividends through a debit, and the dividends expense is credited. In essence, we are updating the capital balance and resetting all temporary account balances.

Four Steps in Preparing Closing Entries

This time period, called the accounting period, usually reflects one fiscal year. However, your business is also free to handle closing entries monthly, quarterly, or every six months. 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). Now that we have closed income and expenses, we need to move the balances from the income summary to retained earnings.

AccountingTools

A business will use closing entries in order to reset the balance of temporary accounts to zero. These accounts have continuous balances that carry forward from one accounting period to another. Examples of accounts not affected by closing entries include asset, liability, and equity accounts. 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.