In summary, the accountant resets the temporary accounts to zero by transferring the balances to permanent accounts. In the short way, we can clear all temporary accounts to retained earnings with a single closing entry. By debiting the revenue account and crediting the dividend and expense accounts, the balance of $3,450,000 is credited to retained earnings. The ninth, and typically final, step of the process is to prepare a post-closing trial balance. The word “post” in this instance means “after.” You are preparing a trial balance after the closing entries are complete.
The account has a zero balance throughout the entire accounting period until the closing entries are prepared. Therefore, it will not appear on any trial balances, including the adjusted trial balance, and will not appear on any of the financial statements. 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. All temporary accounts must be reset to zero at the end of the accounting period.
The entries take place “behind the scenes,” often with no income summary account showing in the chart of accounts or other transaction records. 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. All expense accounts are then closed to the income summary account by crediting the expense accounts and debiting income summary. Closing all temporary accounts to the retained earnings account is faster than using the income summary account method because it saves a step.
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. 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 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?
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. As mentioned, temporary accounts in the general ledger consist of income statement accounts such as sales or expense accounts. When the income statement is published at the end of the year, the balances of these accounts are transferred to the income summary, which is also a temporary account. The purpose of closing entries is to prepare the temporary accounts for the next accounting period.
Income Summary Account
If you have never followed the full process from beginning to end, you will never understand how one of your decisions can impact the final numbers that appear on your financial statements. You will not understand how why the irs discontinued the e your decisions can affect the outcome of your business. The process of preparing the post-closing trial balance is the same as you have done when preparing the unadjusted trial balance and adjusted trial balance.
- Note that by doing this, it is already deducted from Retained Earnings (a capital account), hence will not require a closing entry.
- Accountants perform closing entries to return the revenue, expense, and drawing temporary account balances to zero in preparation for the new accounting period.
- The eighth step in the accounting cycle is preparing closing entries, which includes journalizing and posting the entries to the ledger.
Retained earnings represent the amount your business owns after paying expenses and dividends for a specific time period. Temporary account balances can either be shifted directly to the retained earnings account or to an intermediate account known as the income summary account beforehand. Permanent accounts, on the other hand, track activities that extend beyond the current accounting period. They are housed on the balance sheet, a section of the financial statements that gives investors an indication of a company’s value, including its assets and liabilities. Temporary accounts are used to record accounting activity during a specific period.
4 Purpose of the closing process and prepare closing entries
First, all the various revenue account balances are transferred to the temporary income summary account. This is done through a journal entry that debits revenue accounts and credits the income summary. Closing entries are journal entries made at the end of an accounting period, that transfer temporary account balances into a permanent account. Lastly, prepare a post-closing trial balance to verify that the balances of the permanent accounts are correct and that the temporary accounts have been reset to zero. Once adjusting entries have been made, closing entries are used to reset temporary accounts and transfer their balances to permanent accounts.
Understanding the accounting cycle and preparing trial balances is a practice valued internationally. The Philippines Center for Entrepreneurship and the government of the Philippines hold regular seminars going over this cycle with small business owners. They are also transparent with their internal trial balances in several key government offices. Check out this article talking about the seminars on the accounting cycle and this public pre-closing trial balance presented by the Philippines Department of Health.
What are the closing entries?
Now, it’s time to close the income summary to the retained earnings (since we’re dealing with a company, not a small business or sole proprietorship). The income summary is a temporary account used to make closing entries. To close expenses, we simply credit the expense accounts and debit Income Summary. Closing the books not only helps to ensure the accuracy and completeness of the financial statements but also provides a clean set of books for the next accounting period.
Concluding Remarks: The Importance of Understanding How to Complete the Accounting Cycle
With the use of modern accounting software, this process often takes place automatically. The income statement reflects your net income for the month of December. The third entry requires Income Summary to close to the Retained Earnings account. To get a zero balance in the Income Summary account, there are guidelines to consider. It is the end of the year, December 31, 2018, and you are reviewing your financials for the entire year.
While they tend to be similar and repetitive, it is worth having a good understanding of what entries are being made and why they are being made. The following example of closing entries will assist you in quickly comprehending closing entries. This follows the rule that credits are used to record increases in owners’ equity and debits are used to record decreases. Several internet sites can provide additional information for you on adjusting entries.
Should closing entries be performed before or after adjusting entries?
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 fourth entry closes the Dividends account to Retained Earnings. Closing your accounting books consists of making closing entries to transfer temporary account balances into the business’ permanent accounts.
