Closing Entries Accounting Examples Beginners:Step by Step

This is an optional step in the accounting cycle that you will learn about in future courses should you decide to do an accounting major/minor. Steps 1 through 4 were covered in Chapter 2 and Steps 5 through 7 were covered in Section 3.3. Now that we have closed income and expenses, we need to move the balances from the income summary to retained earnings.

The eighth step in the accounting cycle is preparing closing entries, which includes journalizing and posting the entries to the ledger. 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. In this chapter, we complete the final steps (steps 8 and 9) of the accounting cycle, the closing process.

Visit the website and take a quiz on accounting basics to test your knowledge. Accounts can be closed on a monthly, quarterly, semi-annual or annual basis. It is really determined by a company’s need for financial reporting. Most companies close on a monthly or annual basis but that isn’t to say it is uncommon to see a quarterly or semi-annual close. The year-end closing is the process of closing the books for the year. This involved reviewing, reconciling, and making sure that all of the details in the ledger add up.

The credit to income summary should equal the total revenue from the income statement. 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. All temporary accounts with zero balances were left out of this trial balance. Unlike previous trial balances, the retained earnings figure is included, which was obtained through the closing process. Since dividend and withdrawal accounts are not income statement accounts, they do not typically use the income summary account.

Which accounts have a zero balance after closing entries?

Revenue, expense, and dividend accounts affect retained earnings and are closed so they can accumulate new balances in the next period. This transfer to retained earnings is required for three main reasons. 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.

• One account you’ll want to be aware of when performing closing entries is the income summary account.
• The
  total debit to income summary should match total expenses from the
  income statement.
• For example, the balance of a revenue account will go to the income summary.
• Corporations will close the income summary account to the retained earnings account.
• Notice that the Income Summary account is now zero and is ready for use in the next period.

As an another example, you should shift any balance in the dividends paid account to the retained earnings account, which reduces the balance in the retained earnings account. 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 understanding accounting basics aloe and balance sheets not have a drawing account, but if you paid stockholders, you will have a dividends account. If you paid dividends for the month, you will need to close that account as well. Closing entries are completed at the end of each accounting period after your adjusted trial balance has been run. One of the most important steps in the accounting cycle is creating and posting your closing entries.

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As we mentioned, these include revenue, expense, and dividend accounts. The $1,000 net profit balance generated through the accounting period then shifts. A business will use closing entries in order to reset the balance of temporary accounts to zero.

Example of closing entries

When closing the revenue account, you will take the revenue listed in the trial balance and debit it, to reduce it to zero. As a corresponding entry, you will credit the income summary account, which we mentioned earlier. As part of the closing entry process, the net income (NI) is moved into retained earnings on the balance sheet. The assumption is that all income from the company in one year is held onto for future use. Any funds that are not held onto incur an expense that reduces NI. One such expense that is determined at the end of the year is dividends.

Automate Closing Entries with Deskera

Income and expenses are closed to a temporary clearing account, usually Income Summary. Afterwards, withdrawal or dividend accounts are also closed to the capital account. This is closed by doing the opposite – debit the capital account (decreasing the capital balance) and credit Income Summary. 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). Balances of permanent accounts are carried forward to the subsequent 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. Clear the balance of the expense accounts by debiting income summary and crediting the corresponding expenses. 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. KLO’s adjusted trial balance for the current month is presented below and the temporary accounts are highlighted to demonstrate how these accounts will be closed.

This ensures that your financial operations infrastructure can scale with your business’s growth. 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.

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. Instead the balances in these accounts are moved at month-end to either the capital account or the retained earnings account. It’s important to note that neither the drawing nor the dividends accounts need to be transferred to the income summary account. Corporations will close the income summary account to the retained earnings account.

The expense accounts and withdrawal account will now also be zero. 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. Then you are going to create a journal entry to transfer the balance of each temporary account to the appropriate permanent account. For example, the balance of a revenue account will go to the income summary. No, closing entries are performed after adjusting entries in the accounting cycle.