Having a zero balance in these accounts is important so a business can compare performance across periods, particularly with income. It also helps the business keep thorough records of account balances affecting retained earnings. 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.
- Closing entry to account for draws taken for the month, for sole proprietors and partnerships.
- But if the business has recorded a loss for the accounting period, then the income summary needs to be credited.
- Notice that the balances in the expense accounts are now zero and are ready to accumulate expenses in the next period.
- This is from the income summary to the retained earnings account.
- The next and final step in the accounting cycle is to prepare one last post-closing trial balance.
Closing, or clearing the balances, means returning
the account to a zero balance. Having a zero balance in these
accounts is important so a company can compare performance across
periods, particularly with income. It also helps the company keep
thorough records of account balances affecting retained earnings. 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 first entry closes revenue accounts to the Income Summary account. The second entry closes expense accounts to the Income Summary account.
Income Summary
Adjusting entries ensure that revenues and expenses are appropriately recognized in the correct accounting period. The four-step method described above works well because it provides a clear audit trail. For smaller businesses, it might make sense to bypass the income summary account and instead close temporary entries directly to the retained earnings account. 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 year? You have also not incurred any expenses yet for rent,
electricity, cable, internet, gas or food.
If dividends were not declared, closing entries would cease at this point. If dividends are declared, to get a zero balance in the Dividends account, the entry will show a credit to Dividends and a debit to Retained Earnings. As you will learn in Corporation Accounting, there are three components to the declaration and payment of dividends. The first part is the date of declaration, which creates the obligation or liability to pay the dividend.
Record To Report
However, your business is also free to handle closing entries monthly, quarterly, or every six months. The retained earnings account is reduced by the amount paid out in dividends through a debit, and the dividends expense is credited. Close the income summary account by debiting income summary and crediting retained earnings.
Closing Entries: Everything You Need to Know (+How to Post Them)
Assume Bill’s Brewery earns $10,000 of income for the year and has $5,000 of expenses. All temporary accounts must be reset to zero at the end of the accounting period. To do this, their balances are emptied into the income summary account. The income summary account then transfers the net balance of all the temporary accounts to retained earnings, which is a permanent account on the balance sheet. There may be a scenario where a business’s revenues are greater than its expenses. This means that the closing entry will entail debiting income summary and crediting retained earnings.
Second, the closing process updates the retained earnings account to its correct end of period balance. Recall that the balance in the retained earnings comes from the statement of change in equity and not the adjusted trial balance. The transfer to retained earnings is the mechanism that updates the actual retained earnings account balance in the general ledger.
How to Post Closing Entries
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 accrued vs deferred revenue always have a zero balance at the start of the year because they are always closed at the end of the previous year. A business will use closing entries in order to reset the balance of temporary accounts to zero.
But if the business has recorded a loss for the accounting period, then the income summary needs to be credited. The closing entries are the journal entry form of the Statement of Retained Earnings. The first entry
closes revenue accounts to the Income Summary account. The second
entry closes expense accounts to the Income Summary account.
The statement of retained earnings shows the period-ending retained earnings after the closing entries have been posted. When you compare the retained earnings ledger (T-account) to the statement of retained earnings, the figures must match. You should recall from your previous material that retained earnings are the earnings retained by the company over time—not cash flow but earnings. Now that we have closed the temporary accounts, let’s review what the post-closing ledger (T-accounts) looks like for Printing Plus. The first entry requires revenue accounts close to the Income Summary account. To get a zero balance in a revenue account, the entry will show a debit to revenues and a credit to Income Summary.
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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. 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 balance is in retained earnings. To further clarify this concept, balances are closed to assure all revenues and expenses are recorded in the proper period and then start over the following period. The revenue and expense accounts should start at zero each period, because we are measuring how much revenue is earned and expenses incurred during the period. However, the cash balances, as well as the other balance sheet accounts, are carried over from the end of a current period to the beginning of the next period.
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. 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. Closing entries are completed at the end of each accounting period after your adjusted trial balance has been run. 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).
Step 2: Close all expense accounts to Income Summary
These ending balances will carry forward and become the beginning balances in the next period. The income and expenses accounts, on the other hand, will have a zero ending balance and will start the next year with a zero balance. 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. All expense accounts are then closed to the income summary account by crediting the expense accounts and debiting income summary. Closing all temporary accounts to the retained earnings account is faster than using the income summary account method because it saves a step.
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. However, you might wonder, “Where are the revenue, expense, and dividend accounts? If we expand the view, we’ll find the usual suspects—the temporary accounts.