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That’s exactly what we will be answering in this guide –  along with the basics of properly creating closing entries for your small business accounting. The Income Summary balance is ultimately closed to the capital account. 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. The Retained Earnings account balance
is currently a credit of $4,665.

  1. After preparing the closing entries above, Service Revenue will now be zero.
  2. If you paid dividends for the month, you will need to close that account as well.
  3. Notice that the Income Summary account is now zero and is ready
    for use in the next period.
  4. Closing, or clearing the balances, means returning
    the account to a zero balance.
  5. In this chapter, we complete the final steps (steps 8 and 9) of the accounting cycle, the closing process.

Once adjusting entries have been made, closing entries are used to reset temporary accounts and transfer their balances to permanent accounts. The purpose of closing entries is to prepare the temporary accounts for the next accounting period. In other words, the income and expense accounts are “restarted”. The nominal account or revenue accounts, i.e. income and expenses, are closed by providing closing entries after the financial statements are prepared. Because the effect of nominal accounts cannot be shown in the following year, they are closed in the year in which they are created. 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.

Financial Accounting

Now that we know the basics of closing entries, in theory, let’s go over the step-by-step process of the entire closing procedure through a practical business example. Keep in mind, however, that this account is only purposeful for closing the books, and thus, it is not recorded into any accounting reports and has a zero balance at the end of the closing process. After most of the cycle is completed and financial statements are generated, there’s one last step in the process known as closing your books. And so, the amounts in one accounting period should be closed so that they won’t get mixed with those in the next period. 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).

The Income Summary account has a new credit balance of $4,665, which is the difference between revenues and expenses (Figure 5.5). The balance in Income Summary is the same figure as what is reported on Printing Plus’s Income Statement. The accounts that need to start with a clean or $0 balance going into the next accounting period are revenue, income, and any dividends from January 2019.

8: Closing Entries

The cost of goods sold is an account that displays the balance of the total cost amount that the company used to produce the products sold. To find the Expenses, just like for Revenue, you would also find it in the Income Statement. The expenses would be listed in the expense section, so you would need to find the total costs. Depending on the company, there could be many different expenses.

Practice Question: Preparing a Closing Entry

The trial balance shows the ending balances
of all asset, liability and equity accounts remaining. The main
change from an adjusted trial balance is revenues, expenses, closing entries are 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.

We don’t want the 2015 revenue account to show 2014 revenue numbers. 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.

Closing Entry makes it look like a simple process but contains many different tasks in which one slip-up would change the entire results. Stakeholders can have a clearer picture of the company’s performance by documenting non-operating expenses separately from operating expenses. Costs not primarily connected to ongoing business activities are non-operating expenses. For example, interest on debt, restructuring charges, inventory write-offs, and payments to settle lawsuits are a few examples of non-operating costs. Operating expenses include employee salaries and office supplies incurred by a firm to maintain it. The cost of goods sold (materials, direct labor, manufacturing overhead) and capital expenditures are not included in operating expenses (larger expenses such as buildings or machines).

This means that it is not an asset, liability, stockholders’ equity, revenue, or expense account. The account has a zero balance throughout the entire accounting period until the prepared. Therefore, it will not appear on any trial balances, including the adjusted trial balance, and will not appear on any of the financial statements. The expense accounts have debit balances so to get rid of their balances we will do the opposite or credit the accounts.

The T-account summary for Printing Plus after closing entries are journalized is presented in Figure 5.7. Printing Plus has a $4,665 credit balance in its Income Summary account before closing, so it will debit Income Summary and credit Retained Earnings. It is the end of the year, December 31, 2018, and you are reviewing your financials for the entire year. You see that you earned $120,000 this year in revenue and had expenses for rent, electricity, cable, internet, gas, and food that totaled $70,000.

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.

C. If the income exceeds the cost in the income summary account, the result is a net profit, for which income summary account shows a credit balance. A closing entry is provided for the closing of income-expenditure accounts. At the end of each accounting period, financial statements are prepared to determine the financial status of the company. The fourth entry requires Dividends to close to the Retained Earnings account.

Mary Girsch-Bock is the expert on accounting software and payroll software for The Ascent. The income statement reflects your net income for the month of December. All accounts can be classified as either permanent (real) or
temporary (nominal) (Figure
5.3). The following example of closing entries will assist you in quickly comprehending closing entries. When preparing closing entries, there are a few things to bear in mind.