The month-end close is when a business collects financial accounting information. Using the above steps, let’s go through an example of what the closing entry process may look like. This entry zeros out dividends and reduces retained earnings by total dividends paid.
In accounting terms, these journal entries are termed as closing entries. The main purpose of these closing entries is to bring the temporary journal account balances to zero for the next accounting period, which keeps the accounts reconciled. We see from
the adjusted trial balance that our revenue accounts have a credit
balance. To make them zero we want to decrease the balance or do
the opposite. We will debit the revenue accounts and credit the
Income Summary account.
- In the event of a loss for the period, the income summary account needs to be credited and retained earnings reduced through a debit.
- Permanent accounts are accounts that show the long-standing financial position of a company.
- A closing entry is a journal entry that is made at the end of an accounting period to transfer balances from a temporary account to a permanent account.
This is from the income summary to the retained earnings account. Once this is done, it is then credited to the business’s retained earnings. A business will use closing entries in order to reset the balance of temporary accounts to zero. Once you have completed and posted all closing entries, the final step is to print a post-closing trial balance, and review it to ensure that all entries were made correctly. The remaining balance in Retained Earnings is $4,565 (Figure 5.6).
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. The next step is to repeat the same process for your business’s expenses. All expenses can be closed out by crediting the expense accounts and debiting the income summary.
The information needed to prepare closing entries comes from the adjusted trial balance. 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 closing entries are 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.
Once all of the required entries have been made, you can run your post-closing trial balance, as well as other reports such as an income statement or statement of retained earnings. However, some corporations use a temporary clearing account for dividends declared (let's use "Dividends"). 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. In a partnership, a drawing account is maintained for each partner.
In summary, the accountant resets the
temporary accounts to zero by transferring the balances to
permanent accounts. The expense accounts have debit balances so to
get rid of their balances we will do the opposite or credit the
accounts. Just like in step 1, we will use Income Summary as the
offset account but this time we will debit income a guide to accounting for a nonprofit organization summary. The
total debit to income summary should match total expenses from the
income statement. Closing entries are the journal entries used to transfer the balances of these temporary accounts to permanent accounts. The expense accounts have debit balances so to get rid of their balances we will do the opposite or credit the accounts.
And unless you’re extremely knowledgeable in how the accounting cycle works, it’s likely you’ll make a few accounting errors along the way. The fourth entry requires Dividends to close to the Retained
Earnings account. Remember from your past studies that dividends
are not expenses, such as salaries paid to your employees or staff.
Permanent versus Temporary Accounts
This means that the closing entry will entail debiting income summary and crediting retained earnings. But if the business has recorded a loss for the accounting period, then the income summary needs to be credited. Made at the end of an accounting period, it transfers balances from a set of temporary accounts to a permanent account. Essentially resetting the account balances to zero on the general ledger. Closing entries are those journal entries made in a manual accounting system at the end of an accounting period to shift the balances in temporary accounts to permanent accounts. Temporary accounts are used to compile transactions that impact the profit or loss of a business during a year, while permanent accounts maintain an ongoing balance over time.
- The
total debit to income summary should match total expenses from the
income statement. - Companies are required to close their books at the end of each
fiscal year so that they can prepare their annual financial
statements and tax returns. - Closing entries prepare a company for the next accounting period by clearing any outstanding balances in certain accounts that should not transfer over to the next period.
- To get a zero balance in the Income Summary
account, there are guidelines to consider.
Income summary is not reported on any financial statements because it is only used during the closing process, and at the end of the closing process the account balance is zero. Temporary accounts are accounts in the general ledger that are used to accumulate transactions over a single accounting period. The balances of these accounts are eventually used to construct the income statement at the end of the fiscal year. Closing entries, on the other hand, are entries that close temporary ledger accounts and transfer their balances to permanent accounts. The purpose of closing entries is to merge your accounts so you can determine your retained earnings. Retained earnings represent the amount your business owns after paying expenses and dividends for a specific time period.
Unit 4: Completion of the Accounting Cycle
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.
Closing entries definition
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. One such expense that is determined at the end of the year is dividends.
Income Summary
Temporary accounts are used to record accounting activity during a specific period. All revenue and expense accounts must end with a zero balance because they are reported in defined periods and are not carried over into the future. For example, $100 in revenue this year does not count as $100 of revenue for next year, even if the company retained the funds for use in the next 12 months.
Income summary effectively collects NI for the period and distributes the amount to be retained into retained earnings. Balances from temporary accounts are shifted to the income summary account first to leave an audit trail for accountants to follow. Income summary is a holding account used to aggregate all income accounts except for dividend expenses.
The credit to income summary should equal
the total revenue from the 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. To determine the income (profit or loss) from the month of January, the store needs to close the income statement information from January 2019. The income summary is used to transfer the balances of temporary accounts to retained earnings, which is a permanent account on the balance sheet. A closing entry is a journal entry that is made at the end of an accounting period to transfer balances from a temporary account to a permanent account. 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.
This involved reviewing, reconciling, and making sure that all of the details in the ledger add up. The T-account summary for Printing Plus after closing entries are journalized is presented in Figure 5.7. Let’s explore each entry in more detail using Printing Plus’s information from Analyzing and Recording Transactions and The Adjustment Process as our example.
For corporations, Income Summary is closed entirely to "Retained Earnings". The Income Summary balance is ultimately closed to the capital account. We’ll use a company called MacroAuto that creates and installs specialized exhaust systems for race cars. Well, dividends are not part of the income statement because they are not considered an operating expense. 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. Prepare the closing entries for Frasker Corp. using the adjusted
trial balance provided.
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