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. All expense accounts are then closed to the income summary account by crediting the expense accounts and debiting income summary. Temporary accounts are income statement accounts that are used to track accounting activity during an accounting period.

• The $9,000 of expenses generated through the accounting period will be shifted from the income summary to the expense account.
• All expenses can be closed out by crediting the expense accounts and debiting the income summary.
• Remember, modern computerized accounting systems go through this process in preparing financial statements, but the system does not actually create or post journal entries.
• As part of the closing entry process, the net income (NI) is moved into retained earnings on the balance sheet.
• 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.

In a partnership, a drawing account is maintained for each partner. All drawing accounts are closed to the respective capital accounts at the end of the accounting period. A net loss would decrease owner’s capital, so we would do the opposite in this journal entry by debiting the capital account and crediting Income Summary. 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). Permanent (real) accounts are accounts that
transfer balances to the next period and include balance sheet
accounts, such as assets, liabilities, and stockholders’ equity.

Overview: What are closing entries?

The goal is to zero out your Income and Expense accounts, then add your fiscal year’s net income to Retained Earnings. Below are the T accounts with the journal entries already posted. Notice that the Income Summary account is now zero and is ready
for use in the next period.

• 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.
• The Income Summary account has a credit balance of $10,240
  (the revenue sum).
• He is the sole author of all the materials on AccountingCoach.com.
• Since we credited income summary in Step 1 for $5,300 and debited income summary for $5,050 in Step 2, the balance in the income summary account is now a credit of $250.
• Note that by doing this, it is already deducted from Retained Earnings (a capital account), hence will not require a closing entry.
• We see from the adjusted trial balance that our revenue account has a credit balance.

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. Closing entries take place at the end of an accounting cycle as a set of journal entries. The closing entries serve to transfer these temporary account balances to permanent entries on the company’s balance sheet. This resets the balance of the temporary accounts to zero, ready to begin the next accounting period.

The closing entry will debit both interest revenue and service
revenue, and credit Income Summary. This means that
it is not an asset, liability, stockholders’ equity, revenue, or
expense account. The account has a zero balance throughout the
entire accounting period until the closing entries are prepared. Therefore, gross margin definition it will not appear on any trial balances, including the
adjusted trial balance, and will not appear on any of the financial
statements. Closing entries are those journal entries made in a manual accounting system at the end of an accounting period to shift the balances in temporary accounts to permanent accounts.

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. 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. The second entry requires expense accounts close to the Income
Summary account.

How to Record a Closing Entry

You should recall from your previous material that retained earnings are the earnings retained by the company over time—not cash flow but earnings. Now that we have closed the temporary accounts, let’s review what the post-closing ledger (T-accounts) looks like for Printing Plus. To further clarify this concept, balances are closed to assure all revenues and expenses are recorded in the proper period and then start over the following period. The revenue and expense accounts should start at zero each period, because we are measuring how much revenue is earned and expenses incurred during the period.

When closing expenses, you should list them individually as they appear in the trial balance. That’s why most business owners avoid the struggle by investing in cloud accounting software instead. Well, dividends are not part of the income statement because they are not considered an operating expense. That’s exactly what we will be answering in this guide –  along with the basics of properly creating closing entries for your small business accounting. 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). For corporations, Income Summary is closed entirely to “Retained Earnings”.

Essentially resetting the account balances to zero on the general ledger. The first entry closes revenue accounts to the Income Summary account. The second entry closes expense accounts to the Income Summary account. The third entry closes the Income Summary account to Retained Earnings. The information needed to prepare closing entries comes from the adjusted trial balance. 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.

At the end of the year, all the temporary accounts must be closed or reset, so the beginning of the following year will have a clean balance to start with. In other words, revenue, expense, and withdrawal accounts always have a zero balance at the start of the year because they are always closed at the end of the previous year. The four-step method described above works well because it provides a clear audit trail. For smaller businesses, it might make sense to bypass the income summary account and instead close temporary entries directly to the retained earnings account.

What is a Closing Entry?

These accounts are closed directly to retained earnings by recording a credit to the dividend account and a debit to retained earnings. Closing entries are journal entries you make at the end of an accounting cycle that movie temporary account balances to permanent entries on your company’s balance sheet. 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. Closing entries are journal entries made at the end of an accounting period, that transfer temporary account balances into a permanent account. Notice that the balances in the expense accounts are now zero
and are ready to accumulate expenses in the next period.

Closing entries

For this reason, these types of accounts are called temporary or nominal accounts. When an accountant closes an account, the account balance returns to zero. Starting with zero balances in the temporary accounts each year makes it easier to track revenues, expenses, and withdrawals and to compare them from one year to the next. There are four closing entries, which transfer all temporary account balances to the owner’s capital account. 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.

Examples of Closing Entries

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. Only income statement accounts help us summarize income, so only income statement accounts should go into income summary. Notice that the balances in interest revenue and service revenue are now zero and are ready to accumulate revenues in the next period.

Step 4: Close withdrawals account

The
balance in the Income Summary account equals the net income or loss
for the period. This balance is then transferred to the Retained
Earnings account. 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. Second, just like step one, you need to clear the balance of the expense accounts by debiting income summary and crediting the corresponding expenses.

Whether you’re posting entries manually or using accounting software, all revenue and expenses for each accounting period are stored in temporary accounts such as revenue and expenses. Your closing journal entries serve as a way to zero out temporary accounts such as revenue and expenses, ensuring that you begin each new accounting period properly. The income summary is used to transfer the balances of temporary accounts to retained earnings, which is a permanent account on the balance sheet. Closing journal entries are made at the end of an accounting period to prepare the accounting records for the next period. They zero-out the balances of temporary accounts during the current period to come up with fresh slates for the transactions in the next period. If dividends were not declared, closing entries would cease at
this point.

The Printing Plus adjusted trial balance for January 31, 2019, is presented in Figure 5.4. It is the end of the year, December 31, 2018, and you are reviewing your financials for the entire year. 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.

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. 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. The use of closing entries resets the temporary accounts to begin accumulating new transactions in the next period. Otherwise, the balances in these accounts would be incorrectly included in the totals for the following reporting period.