Closing Entries Financial Accounting

The month-end close is when a business collects financial accounting information. Using the above steps, let’s go through an example of what the closing entry process may look like. The income statement summarizes your income, as does income summary.

  • These accounts are closed directly to retained earnings by recording a credit to the dividend account and a debit to retained earnings.
  • From the Deskera “Financial Year Closing” tab, you can easily choose the duration of your accounting closing period and the type of permanent account you’ll be closing your books to.
  • This balance is then transferred to the Retained
    Earnings account.
  • The income summary account is also a temporary account that is closed out at the end of the period.

Revenue, expense, and dividend accounts affect retained earnings and are closed so they can accumulate new balances in the next period, which is an application of the time period assumption. The income summary account serves as a temporary account used only during the closing process. It contains all the company’s revenues and expenses for the current accounting time period. In other words, it contains net income or the earnings figure that remains after subtracting all business expenses, depreciation, debt service expense, and taxes.

1: Describe and Prepare Closing Entries for a Business

From this trial balance, as we learned in the prior section, you make your financial statements. After the financial statements are finalized and you are 100 percent sure that all the adjustments are posted and everything is in balance, you create and post the closing entries. The closing entries are the last journal entries that get posted to the ledger. The income summary account is an intermediary
between revenues and expenses, and the Retained Earnings account. It stores all of the closing information for revenues and expenses,
resulting in a “summary” of income or loss for the period.

  • 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.
  • We’ll use a company called MacroAuto that creates and installs specialized exhaust systems for race cars.
  • The trial balance is like a snapshot of your business’s financial health at a specific moment.
  • These posted entries will then translate into a
    post-closing trial balance, which is a trial
    balance that is prepared after all of the closing entries have been
  • 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).

In this example we will close Paul’s Guitar Shop, Inc.’s temporary accounts using the income summary account method from his financial statements in the previous example. On the statement of retained earnings, we reported the ending balance of retained earnings to be $15,190. We need to do the closing entries to make them match and zero out the temporary accounts. In partnerships, a compound entry transfers each partner’s share of net income or loss to their own capital account.

What Are Closing Entries?

The total debit to income summary should match total expenses from the income statement. 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.

Step 4: Closing the drawing/dividends account

Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years. He is the sole author of all the materials on Now, if you’re new to accounting, you probably have a ton of questions.

Step 2: Closing the expense accounts

It is
important to understand retained earnings is not closed out, it is only updated. Retained
Earnings is the only account that appears in the closing entries
that does not close. You should recall from your previous material
that retained earnings are the earnings retained by the company
over time—not cash flow but earnings.

Lastly, if we’re dealing with a company that distributes dividends, we have to transfer these dividends directly to retained earnings. In other words, they represent the long-standing finances of your business. 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. Mary Girsch-Bock is the expert on accounting software and payroll software for The Ascent. The income statement reflects your net income for the month of December.

Temporary (nominal) accounts are accounts that
are closed at the end of each accounting period, and include income
statement, dividends, and income summary accounts. 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.

All revenue accounts are first transferred to the income summary. Here you will focus on debiting all of your business’s revenue accounts. 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.

The first part is the date of declaration, which creates the obligation or liability to pay the dividend. The second part is the date of record that determines who receives the dividends, and the third part is the date of payment, which is the date that payments are made. Printing Plus has $100 of dividends with a debit balance on the adjusted trial balance. The closing entry will credit Dividends and debit Retained Earnings.

Notice that revenues, expenses, dividends, and income summary
all have zero balances. The post-closing T-accounts will be transferred to the
post-closing trial balance, which is step 9 in the accounting
cycle. You might be asking yourself, “is the Income Summary account
even necessary? ” Could we just close out revenues and expenses
directly into retained earnings and not have this extra temporary
account? We could do this, but by having the Income Summary
account, you get a balance for net income a second time. This gives
you the balance to compare to the income statement, and allows you
to double check that all income statement accounts are closed and
have correct amounts.

Lengthy accounting cycles and inaccurate projections can result in revenue leaks costing companies millions. Then, just pick the specific date and year you want the closing process to take place, and you’re done! In just a few clicks, the entire financial year closing is streamlined for you. Retained earnings are those earnings not distributed to shareholders as dividends, but retained for further investment, often in advertising, sales, production, and equipment.

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 how to set up an etsy shop year? You have also not incurred any expenses yet for rent,
electricity, cable, internet, gas or food. 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. Our discussion here begins with journalizing and posting the
closing entries (Figure