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. What are your total expenses for
rent, electricity, cable and internet, gas, and food for the
current year? You have also not incurred any expenses yet for rent,
electricity, cable, internet, gas or food.
- We see from the adjusted trial balance that our revenue accounts have a credit balance.
- If both summarize
your income in the same period, then they must be equal. - These accounts are be zeroed and their balance should be transferred to permanent accounts.
- The first entry
closes revenue accounts to the Income Summary account. - These accounts are temporary because they keep their balances during the current accounting period and are set back to zero when the period ends.
- By debiting the revenue account and crediting the dividend and expense accounts, the balance of $3,450,000 is credited to retained earnings.
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.
This is closed by doing the opposite – debit the capital account (decreasing the capital balance) and credit Income Summary. The next and final step in the accounting cycle is to prepare one last post-closing trial balance. Clear the balance of the revenue account by debiting revenue and crediting income summary. The general ledger is the central repository of all accounts and their balances, including the closing entries.
Should closing entries be performed before or after adjusting entries?
The income summary is a temporary account used to make closing entries. The fourth entry requires Dividends to close to the Retained
Earnings what does it mean to be in the black or in the red account. Remember from your past studies that dividends
are not expenses, such as salaries paid to your employees or staff.
- In essence, we are updating the capital balance and resetting all temporary account balances.
- The general journal is used to record various types of accounting entries, including closing entries at the end of an accounting period.
- We see from the adjusted trial balance that our revenue account has a credit balance.
- The Retained Earnings account balance is currently a credit of $4,665.
- Take note that closing entries are prepared only for temporary accounts.
- This reflects your net income for the month, and increases your capital account by $250.
Only income
statement accounts help us summarize income, so only income
statement accounts should go into income summary. After closing, the balance of Expenses will be zero and the account will be ready for the expenses of the next accounting period. At this point, the credit column of the Income Summary represents the firm’s revenue, the debit column represents the expenses, and balance represents the firm’s income for the period. Once this is done, it is then credited to the business’s retained earnings. A business will use closing entries in order to reset the balance of temporary accounts to zero.
Step 4: Transfer Balance
For example, $100 in revenue this year does not count as $100 of revenue for next year, even if the company retained the funds for use in the next 12 months. 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. However, 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. 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.
Step 1: Close Revenue accounts
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. 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.
This ensures that your financial operations infrastructure can scale with your business’s growth. This adjusted trial balance reflects an accurate and fair view of your bakery’s financial position. Prepare the closing entries for Frasker Corp. using the adjusted
trial balance provided.
Example of a Closing Entry
The remaining balance in Retained Earnings is $4,565 (Figure 5.6). This is the same figure found on the statement of retained earnings. Permanent (real) accounts are accounts that transfer balances to the next period and include balance sheet accounts, such as assets, liabilities, and stockholders’ equity. These accounts will not be set back to zero at the beginning of the next period; they will keep their balances. The retained earnings account is reduced by the amount paid out in dividends through a debit, and the dividends expense is credited. This process resets both the income and expense accounts to zero, preparing them for the next accounting period.
Accounts are considered “temporary” when they only accumulate transactions over one single accounting period. Temporary accounts are closed or zero-ed out so that their balances don’t get mixed up with those of the next year. 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. Once you have completed and posted all closing entries, the final step is to print a post-closing trial balance, and review it to ensure that all entries were made correctly.
Closing entries definition
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. 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. In this chapter, we complete the final steps (steps 8 and 9) of the accounting cycle, the closing process.
Notice that the Income Summary account is now zero and is ready for use in the next period. The Retained Earnings account balance is currently a credit of $4,665. Printing Plus has a $4,665 credit balance in its Income Summary account before closing, so it will debit Income Summary and credit Retained Earnings. 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. It is the end of the year, December 31, 2018, and you are reviewing your financials for the entire year.
Instead, declaring and paying dividends is a method utilized by corporations to return part of the profits generated by the company to the owners of the company—in this case, its shareholders. The eighth step in the accounting cycle is preparing closing entries, which includes journalizing and posting the entries to the ledger. 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. Whether you’re processing closing entries manually, or letting your accounting software do the work, closing entries are perhaps the most important part of the accounting cycle. If your business is a corporation, you will not have a drawing account, but if you paid stockholders, you will have a dividends account.