WHAT ARE CLOSING ENTRIES?
CHRISTINE NYANDAT, 24 Oct, 2013
Definition: Closing entries are journal entries made at the end of an accounting period to transfer
temporary accounts to permanent accounts. An "income summary" account may be used to show the
balance between revenue and expenses, or they could be directly closed against retained earnings
where dividend payments will be deducted from. This process is used to reset the balance of these
temporary accounts to zero for the next accounting period
In other words: A journal entry made at the end of the accounting period. The closing entry is used
to transfer data in the temporary accounts to the permanent balance sheet or income statement
accounts. The purpose of the closing entry is to bring the temporary journal account balances to
zero for the next accounting period, which aids in keeping the accounts reconciled.
Why is it important? As with all other journal entries, the closing entries are posted in the general
ledger. After all closing entries have been finished, only the permanent balance sheet and income
statement accounts will have balances that are not zeroed. For example, revenue, dividend, or
expense accounts are temporary accounts that need to be zeroed off and the balance transferred to
permanent accounts.
Lecture notes
The sequence of the closing process and the associated closing entries is:
1. Close revenue accounts to income summary, by debiting revenue and crediting income summary.
2. Close expense accounts to income summary, by debiting income summary and crediting expense.
3. Close income summary to retained earnings, by debiting income summary and crediting retained
earnings.
4. Close dividends to retained earnings, by debiting retained earnings and crediting dividends.
What Is the Purpose of Closing Entries?
A closing entry is used in accounting. The Purpose of a closing entry is to transfer data from the
temporary accounts to the permanent data sheet. The closing entry is to bring the temporary
account journal balance to 0.
What is the difference between adjusting
entries and closing entries?
Adjusting entries are made at the end of the accounting period (but prior to preparing the financial
statements) in order for a company’s accounting records and financial statements to be up-to-date
on the accrual basis of accounting. For example, each day the company incurs wages expense but
the payroll involving workers’ wages for the last days of the month won’t be entered in the
accounting records until after the accounting period ends. Similarly, the company uses electricity
each day but receives only one bill per month, perhaps on the 20th day of the month. The electricity
expense for the last 10-15 days of the month must get into the accounting records if the financial
statements are to show all of the expenses and the amounts owed for the current accounting period.
Other adjusting entries involve amounts that the company paid prior to amounts becoming expenses.
For examples, the company probably paid its insurance premiums for a six month period prior to the
start of the six month period. The company may have deferred the expense by recording the amount
in the asset account Prepaid Insurance. During the accounting period some of those premiums
expired (were used up) and need to appear as expense in the current accounting period and the
asset balance reduced.
Closing entries are dated as of the last day of the accounting period, but they are entered into the
accounts after the financial statements are prepared. For the most part, closing entries involve the
income statement accounts. The closing entries set the balances of all of the revenue accounts and
the expense accounts to zero. This means that the revenue and expense accounts will start the New
Year with nothing in the accounts–allowing the company to easily report the New Year revenues and
expenses. The net amount of all of the balances from the revenue and expense accounts at the end of
the year will end up in retained earnings (for corporations) or owner’s equity (for sole
proprietorships). Thanks to accounting software, the closing entries are quite effortless.
Closing Journal Entries
1. Close Revenue to Income Summary
The balance of the revenue account is the total revenue for the accounting period. Since revenue is
one of the components of the income calculation (the other component being expenses), in the last
day of the accounting period it is closed to the Income Summary account as follows:
Date
Accounts
Mm/dd Revenue
Income summary
Debit
Credit
xxxxxxx
xxxxxx
Once this closing entry is made, the revenue account balance will be zero and the account will be
ready to accumulate revenue at the beginning of the next accounting period.
2. Close Expenses to Income Summary
Expenses are the other component of the income calculation and like revenue, are closed to the
Income Summary account:
Date
Accounts
Debit Credit
Mm/dd
Income
summary
xxxxx
Expenses
xxxxx
After closing, the balance of Expenses will be zero and the account will be ready for the expenses of
the next accounting period. At this point, the credit column of the Income Summary represents the
firm's revenue, the debit column represents the expenses, and balance represents the firm's income
for the period.
3. Close Income Summary to Retained Earnings
The income or loss for the period ultimately adds to or subtracts from the firm's capital. The
Retained Earnings account is a capital account that accumulates the income from each accounting
period. The Income Summary account is closed to Retained Earnings as follows:
Date
Accounts
Debit Credit
Mm/dd Income summary xxxxxx
Retained earnings
xxxxxx
4. Close Dividends to Retained Earnings
Any capital withdrawals (e.g. dividends paid) during the period will reduce the capital account
balance, so the withdrawal is closed to Retained Earnings:
Date
Accounts
Mm/dd Retained earnings
Debit Credit
xxxxx
dividends
xxxxx
After closing, the dividend account will have a zero balance and be ready for the next period's
dividend payments.
Posting of the Closing Entries
As with other journal entries, the closing entries are posted to the appropriate general ledger
accounts. After the closing entries have been posted, only the permanent accounts in the ledger will
have non-zero balances.
Example
ABC International is closing its books for the most recent accounting period. ABC had $50,000 of
revenues and $45,000 of expenses during the period. For simplicity, we will assume that all of the
expenses were recorded in a single account; in a normal environment, there might be dozens of
expense accounts to clear out. The sequence of entries is:
1. Empty the revenue account by debiting it for $50,000, and transfer the balance to the income
summary account with a credit. The entry is:
Debit
revenue
Credit
50,000
Income summary
50,000
2. Empty the expense account by crediting it for $45,000, and transfer the balance to the income
summary account with a debit. The entry is:
Debit Credit
Income summary
expenses
45,000
45,000
3. Empty the income summary account by debiting it for $5,000, and transfer the balance to the
retained earnings account with a credit. The entry is:
Debit Credit
Income summary
Retained earnings
5,000
5,000
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.
Closing Procedure
Having just described the basic closing entries, we must also point out that a practicing accountant
rarely uses any of them, since these steps are handled automatically by any accounting software that
a company uses. Instead, the basic closing step is to access an option in the software to close the
accounting 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.
Take a look at the worksheet below, the blue, green and purple numbers must be zeroed out. These
accounts must be closed.
Spann
Computer
Service
Accounts
Year
Ended
Dec. 31,
20--
Work
Sheet
Trial
Balance
DR
Income
Statement
Adjustments
CR
DR
CR
DR
Balance
Sheet
CR
DR
Bank
4500
4500.00
Accounts
Receivable
2000
2000.00
Supplies
600
455.00
145.00
Prepaid
Insurance
3500
812.50
2687.50
Accounts
Payable
1500
GST Payable
300
125.00
CR
1625.00
300.00
GST
600
Recoverable
600.00
Loan
Payable
250
250.00
W. Spann,
Capital
3500
3500.00
W. Spann,
Drawings
2500
Sales
2500.00
10450
10450.00
Rent
Expense
800
800.00
Wages
Expense
1500
1500.00
16000
16000
Supplies
Expense
455.00
455.00
Insurance
Expense
812.50
812.50
Auto
Expense
50.00
50.00
Misc.
Expense
75.00
75.00
1392.50
Net Income
1392.50 3692.50
10450.00 12432.50 5675.00
6757.50
6757.50
If the
Income is
more than
the
Expenses,
then you
have a
Net
Income
(Profit)
10450.00 10450.00 12432.50 12432.50
**Notice
the two
differences
are placed
under the
lesser
columns.
Steps in Closing Entries
The worksheet contains the data for the closing entries.
There are four steps to this process. They are:
1.
Closing Entry 1 - the Revenue amount(s) are closed to the Income Summary account.
2.
Closing Entry 2 - the Expense amounts are closed to the Income Summary account.
3. Closing Entry 3 - the Balance Sheet balancing figure is closed - the income / loss or Income
Summary to the Capital account.
4.
Closing Entry 4 - the Drawing figure is closed to the Capital
Closing Entry One
The first entry sees the balances in the Revenue account(s) from the worksheet transferred to the
newly created nominal account called Income Summary.
Particulars
Sales
Income Summary
PR Debit Credit
10 450
10 450
Closing Entry Two
Next, we transfer the balances from the Expense accounts - again - from the work sheet, to the
Income Summary account
31 Income Summary
3692.50
Rent Expense
800 -
Wages Expense
1500 -
Supplies Expense
455 -
Insurance Expense
812.50
Auto Expense
50 -
Miscellaneous Expense
75 -
Closing Entry Three
The third closing entry transfers the amount in the Income Summary account to the owner's Capital
account. After the two transactions above, the Income Summary currently has a Credit of $10 450
and a Debit of $3692.50. If you calculate the balance, you will see it is a Credit balance of $6757.50.
The same as the balancing figure in the Work Sheet.
31 Income Summary
6757.50
W. Spann, Capital
6757.50
Closing Entry Four
The last closing entry takes the balance of the Drawings account to the owner's Capital account.
This figure, along with the others is easily recognized from the Work Sheet.
31 W. Spann, Capital
W. Spann,
Drawings
2500 2500 -
Ledger Accounts
If you look at the ledger accounts after the above closing entries have been performed, you will now
see that all of the Nominal (temporary) accounts are closed and only the Real (permanent) accounts
are left. Looking at the ledger accounts you will now see how the accounting equation is put to use
again.