Closing Entry: What It Is and How to Record One

The purpose of the income summary is to show the net income (revenue less expenses) of the business in more detail before it becomes part of the retained earnings account balance. Closing all temporary accounts to the income summary account leaves an audit trail for accountants to follow. The total of the income summary account after the all temporary accounts have been close should be equal to the net income for the period. Temporary accounts are income statement accounts that are used to track accounting activity during an accounting period.

The main change from an adjusted trial balance is revenues, expenses, and dividends are all zero and their balances have been rolled into retained earnings. We do not need to show accounts with zero balances on the trial balances. The process of closing entries in accounting ensures the temporary accounts have a balance of zero at the end of the period. The funds must be transferred into another account, the income summary account, to bring each account balance down to zero. A sole proprietor or partnership often uses a separate drawings account to record withdrawals of cash by the owners. Although the drawings account is not an income statement account, it is still classified as a temporary account and needs a closing journal entry to zero the balance for the next accounting period.

A net loss would decrease retained earnings so we would do the opposite in this journal entry by debiting Retained Earnings and crediting Income Summary. The $1,000 net profit balance generated through the accounting period then shifts. This is from the income summary to the retained earnings account. Once this is done, it is then credited to the business’s retained earnings. A business will use closing entries in order to reset the balance of temporary accounts to zero. After the closing journal entry, the balance on the drawings account is zero, and the capital account has been reduced by 1,300.

Temporary and Permanent Accounts

Closing entries are an important facet of keeping your business’s books and records in order. By maintaining your bookkeeping, you can ensure that you are constantly kept informed. As well as being consistently up-to-date on the financial health of your business.

When are closing entries passed?

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. Closing entries are the journal entries used at the end of an accounting period. Any remaining balances will now be transferred and a post-closing trial balance will be reviewed. Remember that all revenue, sales, income, and gain accounts are closed in this entry. Using the above steps, let’s go through an example of what the closing entry process may look like. The process of using of the income summary account is shown in the diagram below.

This trial balance gives the opening balances for the next accounting period, and contains only balance sheet accounts including the new balance on the retained earnings account as shown below. Made at the end of an accounting period, it transfers balances from a set of temporary accounts to a permanent account. Essentially resetting the account balances to zero on the general ledger. All temporary accounts must be reset to zero at the end of the accounting period.

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 income summary is used to transfer the balances of temporary accounts to retained earnings, which is a permanent account on the balance sheet. A closing entry is a journal entry that is made at the end of an accounting period to transfer balances from a temporary account to a permanent account. Since dividend and withdrawal accounts are not income statement accounts, they do not typically use the income summary account. These accounts are closed directly to retained earnings by recording a credit to the dividend account and a debit to retained earnings. The closing journal entries example comprises of opening and closing balances.

Drawings Accounts and Closing Journals

1. It is also possible to bypass the income summary account and simply shift the balances in all temporary accounts directly into the retained earnings account at the end of the accounting period.
2. As the drawings account is a contra equity account and not an expense account, it is closed to the capital account and not the income summary or retained earnings account.
3. Since dividend and withdrawal accounts are not income statement accounts, they do not typically use the income summary account.
4. The income summary account is another temporary account, only used at the end of an accounting period.
5. Although the drawings account is not an income statement account, it is still classified as a temporary account and needs a closing journal entry to zero the balance for the next accounting period.

Suppose a business had the following trial balance before any closing journal entries at the end of an accounting period. Both closing entries are acceptable and both result in the same outcome. All temporary accounts eventually get closed to retained earnings and are presented on the balance sheet. Closing all temporary accounts to the retained earnings account is faster than using the income summary account method because it saves a step. There is no need to close temporary accounts to another temporary account (income summary account) in order to then close that again. Temporary account balances can the standard deduction be shifted directly to the retained earnings account or an intermediate account known as the income summary account.

As the drawings account understanding operating margin is a contra equity account and not an expense account, it is closed to the capital account and not the income summary or retained earnings account. At the end of the year, all the temporary accounts must be closed or reset, so the beginning of the following year will have a clean balance to start with. 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. Closing entries are put into action on the last day of an accounting period. There are various journals for example cash journal, sales journal, purchase journal etc., which allow users to record transactions and find out what caused changes in the existing balances. Closing entries are mainly used to determine the financial position of a company at the end of a specific accounting period.

What are Closing Entries?

Temporary accounts can be found on the income statement, while permanent accounts are located on the balance sheet. All expense accounts are then closed to the income summary account by crediting the expense accounts and debiting income summary. Income summary effectively collects NI for the period and distributes the amount to be retained into retained earnings.

This list of general ledger accounts with their balances is known as the trial balance. Journal entries are an essential part of the accounting process for any business. Whether your company uses single or double-entry accounting, you will need to ensure the proper method of opening and closing journal entries happens at the designated time. After the closing journal entry, the balance on the dividend account is zero, and the retained earnings account has been reduced by 200.

Although it is not an income statement account, the dividend account is also a temporary account and needs a closing journal entry to zero the balance for the next accounting period. Notice that the effect of this closing journal entry is to credit the retained earnings account with the amount of 1,400 representing the net income (revenue – expenses) of the business for the accounting period. It is also possible to bypass the income summary account and simply shift the balances in all temporary accounts directly into the retained earnings account at the end of the accounting period. As mentioned, temporary accounts in the general ledger consist of income statement accounts such as sales or expense accounts.

All modern accounting software automatically generates closing entries, so these entries are no longer required of the accountant; it is usually not even apparent that these entries are being made. The month-end close is when a business collects financial accounting information. Keep a comprehensive eye on your accounts every period with QuickBooks Online. Try it free today for your next accounting period and see the difference it makes.

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. Companies use closing entries to reset the balances of temporary accounts − accounts that show balances over a single accounting period − to zero. 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 retained earnings account balance has now increased to 8,000, and forms part of the trial balance after the closing journal entries have been made.