Closing Entries Financial Accounting
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. ‘Retained earnings‘ account is credited to record the closing entry for income summary. 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).
By doing so, the company moves these balances into permanent accounts on the balance sheet. These permanent accounts show a company’s long-standing financials. 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 use of closing entries resets the temporary accounts to begin accumulating new transactions in the next period. Otherwise, the balances in these accounts would be incorrectly included in the totals for the following reporting period. 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.
The retained earnings account is reduced by the amount paid out in dividends through a debit, and the dividends expense is credited. Permanent accounts, on the other hand, are balance sheet accounts that maintain a balance from period to period. All asset, liability, and owner’s equity accounts, with the exception on dividends and distributions, carry forward balances from one period to the next. Closing entries transfer the balances from the temporary accounts to a permanent or real account at the end of the accounting year.
- The account has a zero balance throughout the entire accounting period until the closing entries are prepared.
- Since the income summary account is only a transitional account, it is also acceptable to close directly to the retained earnings account and bypass the income summary account entirely.
- This is closed by doing the opposite – debit the capital account (decreasing the capital balance) and credit Income Summary.
- Closing all temporary accounts to the income summary account leaves an audit trail for accountants to follow.
- In summary, the accountant resets the
temporary accounts to zero by transferring the balances to
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. Now for this step, we need to get the balance of the Income Summary account. In step 1, we credited it for $9,850 and debited it in step 2 for $8,790. To close that, we debit Service Revenue for the full amount and credit Income Summary for the same. The income statement
summarizes your income, as does income summary.
The income summary account is also a temporary account that is closed out at the end of the period. Accountants may perform the closing process
monthly or annually. The closing entries are the journal entry form
of the Statement of Retained Earnings.
Step 3: Close Income Summary account
In this case, since it’s an opening trial balance, we’re just getting started with the accounting cycle (Step 1). Let’s investigate an example of how closing journal entries impact a trial balance. Imagine you own a bakery business, and you’re starting a new financial year on March 1st. To close expenses, we simply credit the expense accounts and debit Income Summary.
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. 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. Since the income summary account is only a transitional account, it is also acceptable to close directly to the retained earnings account and bypass the income summary account entirely. The net result of these activities is to move the net profit or net loss for the period into the retained earnings account, which appears in the stockholders’ equity section of the balance sheet.
Final thoughts on closing entries
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 https://intuit-payroll.org/ them match and zero out the temporary
accounts. Now that the journal entries are prepared and posted, you are almost ready to start next year.
All of these entries have emptied the revenue, expense, and income summary accounts, and shifted the net profit for the period to the retained earnings account. The remaining balance in Retained Earnings is $4,565 (Figure 5.6). This is the same figure found on the statement of retained earnings. Notice that the balances in interest revenue and service revenue are now zero and are ready to accumulate revenues in the next period.
Understanding Closing Entries
A closing entry is a journal entry made at the end of accounting periods that involves shifting data from temporary accounts on the income statement to permanent accounts on the balance sheet. Temporary accounts include revenue, expenses, and dividends, and these accounts must be closed at the end of the accounting year. This is no different from what will happen to a company at the end of an accounting period.
The closing entry will debit both interest revenue and service revenue, and credit Income Summary. The first entry closes revenue accounts to the Income Summary account. The second entry closes expense accounts to the Income Summary account.
If you put the revenues and expenses directly
into retained earnings, you will not see that check figure. No
matter which way you choose to close, the same final prepaid insurance journal entry balance is in
retained earnings. As mentioned, temporary accounts in the general ledger consist of income statement accounts such as sales or expense accounts.
The credit to income summary should equal
the total revenue from the income statement. Instead, the basic closing step is to access an option in the software to close the reporting period. Doing so automatically populates the retained earnings account for you, and prevents any further transactions from being recorded in the system for the period that has been closed. 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. Since dividend and withdrawal accounts are not income statement accounts, they do not typically use the income summary account.
The eighth step in the accounting cycle is preparing closing entries, which includes journalizing and posting the entries to the ledger. Companies are required to close their books at the end of each fiscal year so that they can prepare their annual financial statements and tax returns. Clear the balance of the revenue account by debiting revenue and crediting income summary.
This is an optional step in the accounting cycle that you will learn about in future courses. Steps 1 through 4 were covered in Analyzing and Recording Transactions and Steps 5 through 7 were covered in The Adjustment Process. And so, the amounts in one accounting period should be closed so that they won’t get mixed with those in the next period. 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). For corporations, Income Summary is closed entirely to “Retained Earnings”.