Closing Entry Definition, Explanation, and Examples

However, the cash balances, as well as the other balance sheet (permanent) accounts, are carried over from the end of a current period to the beginning of the next period. Closing journal entries are exceptional because, unlike most journal entries, there are no transactions taking place. This means that whatever the normal balance for any given account is, it will be zeroed out by an opposing entry. Thus, if the normal balance is a debit, then a credit will be taken, if the normal balance is a credit, then a debit will be taken. The income summary account (or income summary report) is a special account created to facilitate the closing process and to leave an audit trail. An audit trail makes it easier for someone reviewing accounting books to track the transfer of monies from temporary income statement accounts to permanent balance sheet accounts during the closing entries process.

  • The usual practice is one entry is made for revenue, one for expenses and a final entry for dividends.
  • The closing entries are the journal entry form of the Statement of Retained Earnings.
  • The income summary account doesn’t factor in when preparing financial statements because its only purpose is to be used during the closing process.
  • Closing journal entries are entries compiled at the end of the accounting period to close out temporary accounts to zero balances and prepare them to record activity for the coming accounting period.

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Closing Entries for Revenue Accounts

Close the income summary account by debiting income summary and crediting retained earnings. 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 retained earnings account is reduced by the amount paid out in dividends through a debit, and the dividends expense is credited. Any account listed on the balance sheet, barring paid dividends, is a permanent account. On the balance sheet, $75 of cash held today is still valued at $75 next year, even if it is not spent.

  • If a company’s revenues are greater than its expenses, the closing entry entails debiting income summary and crediting retained earnings.
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  • This is the adjusted trial balance that will be used to make your closing entries.

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. The four most common closing entries are entries to close out the balances in revenue, expense, income summary and dividend accounts.

How, when and why do you prepare closing entries?

All temporary accounts with zero balances were left out of this trial balance. Unlike previous trial balances, the retained earnings figure is included, which was obtained through the closing process. 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. Your closing journal entries serve as a way to zero out temporary accounts such as revenue and expenses, ensuring that you begin each new accounting period properly.

When and where are closing entries prepared and recorded?

Closing entries are journalized and posted once per year at year-end after financial statements have been prepared. Trial Balances: The closing process begins with the adjusted trial balance. After the closing entries have been journalized and posted to the ledger, a Post- Closing trial balance is prepared.

Closing journal entries are entries compiled at the end of the accounting period to close out temporary accounts to zero balances and prepare them to record activity for the coming accounting period. Closing entries differ from other journal entries in that they are used only at the end of the accounting period. It can directly be closed in the retained earnings account or it can be done through a longer process. 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. The first one is to close out the revenue account to the income summary account.