4 7: Closing Entries Business LibreTexts

It can be a closing entries: calendar year for one business while another business might use a fiscal quarter. Dividend account is credited to record the closing entry for dividends. 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. In addition, if the company uses several sets of books for its subsidiaries, the results of each subsidiary must first be transferred to the books of the parent company and all intercompany transactions eliminated. If the subsidiaries also use their own subledgers, then their subledgers must be closed out before the results of the subsidiaries can be transferred to the books of the parent company.

• Notice how only the balance in retained earnings has changed and it now matches what was reported as ending retained earnings in the statement of retained earnings and the balance sheet.
• Income summary account is also a temporary account that is just used at the end of the accounting period to pass the closing entries journal.
• Now that all the temporary accounts are closed, the income summary account should have a balance equal to the net income shown on Paul’s income statement.
• We will debit the revenue accounts and credit the Income Summary account.
• One such expense that’s determined at the end of the year is dividends.
• All of Paul’s revenue or income accounts are debited and credited to the income summary account.

Step 1: Clear revenue to the income summary account

The trial balance shows the ending balances of all asset, liability and equity accounts remaining. 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. We do not need to show accounts with zero balances on the trial balances. We do not need to show accounts with zero balances on the trial balances.

• In contrast, temporary accounts capture transactions and activities for a specific period and require resetting to zero with closing entries.
• 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.
• Permanent accounts, such as asset, liability, and equity accounts, remain unaffected by closing entries.
• The total of the income summary account after the all temporary accounts have been close should be equal to the net income for the period.
• Now, the income summary account has a zero balance, whereas net income for the year ended appears as an increase (or credit) of $14,750.
• The temporary accounts need to be zero at the end of an accounting period.
• Thethird entry closes the Income Summary account to Retained Earnings.The fourth entry closes the Dividends account to Retained Earnings.The information needed to prepare closing entries comes from theadjusted trial balance.

What Is an 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. 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. This is closed by doing the opposite – debit the capital account (decreasing the capital balance) and credit Income Summary. An accounting period is any duration of time that’s covered by financial statements.

Examples of Closing Entries

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. Notice that the balance of the Income Summary account is actually the net income for the period. Remember that net income is equal to all income minus all expenses.

This resets the income accounts to zero and prepares them for the next year. Temporary accounts can either be closed directly to the retained earnings account or to an intermediate account called the income summary account. The income summary account is then closed to the retained earnings 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. As mentioned, one way to make closing entries is by directly closing the temporary balances net sales to the equity or retained earnings account.

• 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 these examples of closing entries in journals have been debited in the expense account.
• The expense accounts have debit balances so to get rid of their balances we will do the opposite or credit the accounts.
• Let’s also assume that ABC Ltd incurred expenses of ₹ 45,00,000 in the raw material purchase, machinery purchase, salary paid to its employees, etc., over the accounting year 2018.
• The T-account summary for Printing Plus after closing entriesare journalized is presented in Figure 5.7.
• The third entry requires Income Summary to close to the RetainedEarnings account.

How to post closing entries?

Both closing entries are acceptable and both result in the same outcome. All temporary accounts eventually get closed to retained earnings and are presented on the balance sheet. Closing all temporary accounts to the retained earnings account is faster than using the income summary account method because it saves a step. There is no need to close temporary accounts to another temporary account (income summary account) in order to then close that again. Total revenue of a firm at the end of an accounting period is transferred to the income summary account to ensure that the revenue account begins with zero balance in the following accounting period.

The expense accounts have debit balances so to get rid of their balances we will do the opposite or credit the accounts. 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 statement of retained earnings shows the period-endingretained earnings after the closing entries have been posted. Whenyou compare the retained earnings ledger (T-account) to thestatement of retained earnings, the figures must match.