A trial balance is a report that adds up all the credits and debits in your business. You want your total credits to be the same number as your total debits—if they aren’t, go back and check your work. If the credits and debits are equal, your accounts balance, and you’re ready to go to the next step.

• On a quartery and annual basis, financial statements are
  created for outside stakeholders as well.
• When you close the books, it’s much easier to accurately compare performance over certain periods and perform accounting actions like remitting taxes.
• In contrast, asset, liability, and equity accounts are called real accounts, as their balances are carried forward from period to period.
• When you close your books at year-end, the accounts aren’t erased; instead, their balances are transferred to a permanent retained earnings account.
• In partnerships, a compound entry transfers each partner’s share of net income or loss to their own capital account.
• The expense accounts could be closed before the revenue accounts; the end result is the same.

The account has a credit balance, which is the net income for the period. Let’s move on to learn about how to record closing those temporary accounts. Even if you ask your accountant to close your books for you, it’s important to understand the basic steps involved so you know what to expect.

Closing The Books

If it’s not, the book cannot be closed, and your accountant or bookkeeper will try to figure out why there’s a discrepancy. A post-closing trial balance is a list of all accounts and their balances after we have updated account balances for adjusting entries. The expense accounts could be closed before the revenue accounts; the end result is the same. We’ll use a company called MacroAuto that creates and installs specialized exhaust systems for race cars. Here are MacroAuto’s accounting records simplified, using positive numbers for increases and negative numbers for decreases instead of debits and credits in order to save room and to get a higher-level view.

But closing the books for the financial year is more important for reflecting the correct retained earnings numbers on the balance sheet, which allows the start of a fresh financial year for profit and loss reporting. Before creating your final report, generate a trial balance, and if things are not adding up, check your work and enter adjusting entries until you are ready to create the final financial statement. Closing is a mechanism to update the Retained Earnings account in the ledger to equal the end-of-period balance. Keep in mind that the recording of revenues, expenses, and dividends do not automatically produce an updating debit or credit to Retained Earnings. As such, the beginning- of-period retained earnings amount remains in the ledger until the closing process “updates” the Retained Earnings account for the impact of the period’s operations.

Resources for Your Growing Business

• Closing the expense accounts—transferring the balances in the expense accounts to a clearing account called Income Summary. • Closing the revenue accounts—transferring the balances in the revenue accounts to a clearing account called Income Summary. These temporary or “nominal” accounts are zeroed out and reset when closing entries are added to an accounting system so they don’t affect the next accounting period. Adjusting entries record items that aren’t noted in daily transactions. These items include accumulation (known as “accrual” in accounting) of real estate taxes or depreciation accrual, which need to be recorded to close the books.

This can mean the rendering of the service and the payment of the bill end up occurring during 2 different accounting periods. Closing the books can help you stop payments from being recorded in the wrong period. Your accountant often does these steps or uses professional accounting software to reduce errors. MicroTrain’s Income Summary account now has a credit balance of USD 7,290, the company’s net income for December.

Types of Accounts

In Chapter 2, you learned that revenue, expense, and dividends accounts are nominal (temporary) accounts that are merely subclassifications of a real (permanent) account, Retained Earnings. You also learned that we prepare financial statements for certain accounting periods. The closing process reduces revenue, the closing process is sometimes referred to as closing the books expense, and Dividends account balances to zero so they are ready to receive data for the next accounting period. To update the balance in the owner’s capital account, accountants close revenue, expense, and drawing accounts at the end of each fiscal year or, occasionally, at the end of each accounting 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. The income summary account doesn’t factor in when preparing financial statements because its only purpose is to be used during the closing process. Revenues appear in the Income Statement credit column of the work sheet. The two revenue accounts in the Income Statement credit column for MicroTrain Company are service revenue of USD 13,200 and interest revenue of USD 600 (Exhibit 20).