Prepare the closing entries for Frasker Corp. using the adjusted trial balance provided. In this chapter, we complete the final steps (steps 8 and 9) of the accounting cycle, the closing process. This is an optional step in the accounting cycle that you will learn about in future courses.

The retained earnings account balance has now increased to 8,000, and forms part of the trial balance after the closing journal entries have been made. This trial balance gives the opening balances for the next accounting full service payroll period, and contains only balance sheet accounts including the new balance on the retained earnings account as shown below. It is permanent because it is not closed at the end of each accounting period.

As mentioned, temporary accounts in the general ledger consist of income statement accounts such as sales or expense accounts. When the income statement is published at the end of the year, the balances of these accounts are transferred to the income summary, which is also a temporary account. A term often used for closing entries is “reconciling” the company’s accounts. Accountants perform closing entries to return the revenue, expense, and drawing temporary account balances to zero in preparation for the new accounting period. In order to close out your expense accounts, you will need to debit the income summary account, and credit each line item expense listed in the trial balance, which reduces the expense account balances to zero. Once adjusting entries have been made, closing entries are used to reset temporary accounts and transfer their balances to permanent accounts.

  1. First, transfer the $5,000 in your revenue account to your income summary account.
  2. All expense accounts are then closed to the income summary account by crediting the expense accounts and debiting income summary.
  3. In step 1, we credited it for $9,850 and debited it in step 2 for $8,790.
  4. To get a zero balance in a revenue account, the entry will show a debit to revenues and a credit to Income Summary.
  5. It is permanent because it is not closed at the end of each accounting period.

The income summary account is a temporary account solely for posting entries during the closing process. It is a holding account for revenues and expenses before they are transferred to the retained earnings account. Transferring funds from temporary to permanent accounts also updates your small business retained earnings account. You can report retained earnings either on your balance sheet or income statement. Without transferring funds, your financial statements will be inaccurate.

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. Companies use closing entries to reset the balances of temporary accounts − accounts that show balances over a single accounting period − to zero.

All the temporary accounts, including revenue, expense, and dividends, have been reset to zero. The balances from these temporary accounts have been transferred to the permanent account, retained earnings. In summary, permanent accounts hold balances that persist from one period to another. In contrast, temporary accounts capture transactions and activities for a specific period and require resetting to zero with closing entries.

Understanding Closing Entries

Closing entries take place at the end of an accounting cycle as a set of journal entries. The closing entries serve to transfer these temporary account balances to permanent entries on the company’s balance sheet. This resets the balance of the temporary accounts to zero, ready to begin the next accounting period. Closing entries are entries used to shift balances from temporary to permanent accounts at the end of an accounting period. These journal entries condense your accounts so you can determine your retained earnings, or the amount your business has after paying expenses and dividends. Creating closing entries is one of the last steps of the accounting cycle.

Overview: What are closing entries?

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. To determine the income (profit or loss) from the month of January, the store needs to close the income statement information from January 2019. Both closing entries are acceptable and both result in the same outcome.

Temporary account balances can either be shifted directly to the retained earnings account or to an intermediate account known as the income summary account beforehand. As part of the closing entry process, the net income (NI) is moved into retained earnings on the balance sheet. The assumption is that all income from the company in one year is held onto for future use. Any funds that are not held onto incur an expense that reduces NI.

What Are Closing Entries?

One of the most important steps in the accounting cycle is creating and posting your closing entries. 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 we expand the view, we’ll find the usual suspects—the temporary accounts. These accounts were reset to zero at the end of the previous year to start afresh. Let’s say your business wants to create month-end closing entries. During the accounting period, you earned $5,000 in revenue and had $2,500 in expenses. If your revenues are less than your expenses, you must credit your income summary account and debit your retained earnings account. If your revenues are greater than your expenses, you will debit your income summary account and credit your retained earnings account.

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. Below are examples of closing entries that zero the temporary accounts in the income statement and transfer the balances to the permanent retained earnings account. After the closing entries have been made, the temporary account balances will be reflected in the Retained Earnings (a capital account). However, an intermediate account called Income Summary usually is created.

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. As the drawings account is a contra equity account and not an expense account, it is closed to the capital account and not the income summary or retained earnings account. Suppose a business had the following trial balance before any closing journal entries at the end of an accounting period.

Temporary accounts are used to accumulate income statement activity during a reporting period. The use of closing entries resets the temporary accounts to begin accumulating new transactions in the next period. Otherwise, the balances in these accounts would be incorrectly included in the totals for the following reporting period. In the short way, we can clear all temporary accounts to retained earnings with a single closing entry.

Delivered as SaaS, our solutions seamlessly integrate bi-directionally with multiple systems including ERPs, HR, CRM, Payroll, and banks. The general journal is used to record various types of accounting entries, including closing entries at the end of an accounting period. The general ledger is the central repository of all accounts and their balances, including the closing entries. These permanent accounts form the foundation of your business’s balance sheet. Next, transfer the $2,500 in your expense account to your income summary account. First, transfer the $5,000 in your revenue account to your income summary account.

Notice that the balances in the expense accounts are now zero and are ready to accumulate expenses in the next period. 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 second entry requires expense accounts close to the Income Summary account. To get a zero balance in an expense account, the entry will show a credit to expenses and a debit to Income Summary.

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.