Closing entries explanation, process and example

If your expenses for December had exceeded your revenue, you would have a net loss. When closing expenses, you should list them individually as they appear in the trial balance. The T-account summary for Printing Plus after closing entries are journalized is presented in Figure 5.7. Notice that the Income Summary account is now zero and is ready for use in the next period.

  1. If your expenses for December had exceeded your revenue, you would have a net loss.
  2. The following steps need to be taken to close the temporary accounts.
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  4. After the posting of this closing entry, the income summary now has a credit balance of $14,750 ($70,400 credit posted minus the $55,650 debit posted).
  5. Therefore, these accounts still have a balance in the new year, because they are not closed, and the balances are carried forward from December 31 to January 1 to start the new annual accounting period.

They’d record declarations by debiting Dividends Payable and crediting Dividends. If this is the case, then this temporary dividends account needs to be closed at the end of the period to the capital account, Retained Earnings. In a sole proprietorship, a drawing account is maintained to record all withdrawals made by the owner. All drawing accounts are closed to the respective capital accounts at the end of the accounting period.

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After the closing journal entry, the balance on the dividend account is zero, and the retained earnings account has been reduced by 200. When closing the revenue account, you will take the revenue listed in the trial balance and debit it, to reduce it to zero. As a corresponding entry, you will credit the income summary account, which we mentioned earlier. No, closing entries are performed after adjusting entries in the accounting cycle. Adjusting entries ensure that revenues and expenses are appropriately recognized in the correct accounting period. Only income statement accounts help us summarize income, so only income statement accounts should go into income summary.

The second entry closes expense accounts to the Income Summary account. The third entry closes the Income Summary account to Retained Earnings. The information needed to prepare closing entries comes from the adjusted trial balance. 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.

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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”. As a result, all temporary accounts will have data for the entire calendar year. The income-expenditure account of the business organization is related to the corresponding accounting period.

Doing this would bring the balances of the Expenses Account to zero. We at Deskera offer the best accounting software for small businesses today. Our program is specifically developed for you to easily set up your closing process and initiate book closing within seconds – no prior technical knowledge necessary. Lastly, if we’re dealing with a company that distributes dividends, we have to transfer these dividends directly to retained earnings. In the next tutorial, we’ll look at the income summary account in more detail. Notice that the balance of the Income Summary account is actually the net income for the period.

Step 2: Closing the expense accounts

The longer process requires temporary accounts to be closed in an intermediate income summary account first and then that account is zeroed out to the retained earnings. The result in both cases is the same and depends on the bookkeeper’s preference or company’s policy on it. After preparing the closing entries above, Service Revenue will now be zero. Instead, companies closing entries example transfer the net income or net loss from the revenue and expense accounts to a temporary account called “Income Summary,” and then to the owner’s capital. Closing entries is entries made to close and clear the revenue and expense accounts and to transfer the amount of the net income or loss to a capital account or accounts or to the retained earning accounts.

When preparing closing entries, there are a few things to bear in mind. This follows the rule that credits are used to record increases in owners’ equity and debits are used to record decreases. Closing entries help in the reconciliation of accounts which facilitates in controlling the overall financials of a firm. You might not feel like an expert in closing entries just yet but you can always refer back to refresh your memory. Imagine we are doing a month-end or year-end close, we’re going to follow these steps.

Closing entries are mainly used to determine the financial position of a company at the end of a specific accounting period. Now that the journal entries are prepared and posted, you are almost ready to start next year. Remember, modern computerized accounting systems go through this process in preparing financial statements, but the system does not actually create or post journal entries. Once all of the temporary accounts have been closed, review the journal entries to ensure that they are accurate and complete. As we mentioned, the income summary is a temporary account in itself.

Note that by doing this, it is already deducted from Retained Earnings (a capital account), hence will not require a closing entry. Take note that closing entries are prepared only for temporary accounts. Temporary accounts include all revenue and expense accounts, and also withdrawal accounts of owner/s in the case of sole proprietorships and partnerships (dividends for corporations). Our discussion here begins with journalizing and posting the closing entries (Figure 1.26).

Then, just pick the specific date and year you want the closing process to take place, and you’re done! In just a few clicks, the entire financial year closing is streamlined for you. Here we see that total expenses for both were $9,650 for January 2020.

Lastly, you’ll repeat the process for each temporary account that you have to close. Alright, with a high-level understanding let’s dive into the 4-step close process. The process of using of the income summary account is shown in the diagram below. This entry zeros out dividends and reduces retained earnings by total dividends paid. It effortlessly sifts through large amounts of data and generates closing entries automatically. This ensures that your financial operations infrastructure can scale with your business’s growth.

If a company’s revenues are greater than its expenses, the closing entry entails debiting income summary and crediting retained earnings. In the event of a loss for the period, the income summary account needs to be credited and retained earnings reduced through a debit. If the income summary account has a debit balance, it means the business has suffered a loss during the period and decreased its retained earnings.

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Here Bob needs to debit retained earnings account and credit dividends account. Here we need to debit retained earnings account and credit dividends account. When dividends are declared by corporations, they are usually recorded by debiting Dividends Payable and crediting Retained Earnings.

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