5 1 Describe and Prepare Closing Entries for a Business Principles of Accounting, Volume 1: Financial Accounting
These posted entries will then translate into a post-closing trial balance, which is a trial balance that is prepared after all of the closing entries have been recorded. After the closing journal entry, the balance on the drawings account is zero, and the capital account has been reduced by 1,300. The retained earnings account is reduced by the amount paid out in dividends through a debit, and the dividends expense is credited. Accounts Payable Journal Entries refer to the amount payable accounting entries to the company’s creditors for the purchase of goods or services. They are reported under the head current liabilities on the balance sheet, and this account is debited whenever any payment has been made. 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.
Closing Entries are journal entries necessary to close income or loss for the period to retained earnings. Revenues or income are debited and expenses are credited, which determines the amount to be closed to retained earnings at the end of an accounting period. The accountant closes entries at the end of each accounting period involving revenues, gains, expenses, and losses. The accountant debits expenses, and incomes are credited to the income summary statement. The amount of each debit entered into an account will be the amount of each account’s credit balance. Notice that the balances in the expense accounts are now zero and are ready to accumulate expenses in the next period.
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. The last closing entry reduces the amount retained by the amount paid out to investors. The purpose of the closing entry is to reset the temporary account balances to zero on the general ledger, the record-keeping system for a company’s financial data. Now that the journal entries are prepared and posted, you are almost ready to start next year.
Now that we have closed the temporary accounts, let’s review what the post-closing ledger (T‑accounts) looks like for Printing Plus. The first entry closes revenue accounts to the Income Summary account. The second entry closes expense accounts to the Income Summary account.
Notice that the balances in interest revenue and service revenue are now zero and are ready to accumulate revenues in the next period. The Income Summary account has a credit balance of $10,240 (the revenue sum). The eighth step in the accounting cycle is preparing closing entries, which includes journalizing and posting the entries to the ledger. In addition, if the accounting system uses subledgers, it must close out each subledger for the month prior to closing the general ledger for the entire company.
The income summary account is an intermediary between revenues and expenses, and the Retained Earnings account. It stores all of the closing information for revenues and expenses, resulting in a “summary” of income or loss for the period. The balance in the Income Summary account equals the net income or loss for the period. This balance is then transferred to the Retained Earnings account. What is the current book value of your electronics, car, and furniture? Are the value of your assets and liabilities now zero because of the start of a new year?
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We want income statements to start every year from zero, but for accounts like equipment, debt, and cash accounts—reported on the balance sheet—we want to keep a running balance from the beginning of the business. 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. Printing Plus has $100 of supplies expense, $75 of depreciation expense–equipment, $5,100 of salaries expense, and $300 of utility expense, each with a debit balance on the adjusted trial balance. The closing entry will credit Supplies Expense, Depreciation Expense–Equipment, Salaries Expense, and Utility Expense, and debit Income Summary. The first entry requires revenue accounts close to the Income Summary account.
The closing entry will credit Dividends and debit Retained Earnings. Learn how to write closing journal entries for revenue, expense, and dividend accounts. 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.
Example of Closing Entries
To make the balance zero, debit the revenue account and credit the Income Summary account. Other accounting software, such as Oracle’s PeopleSoft™, post closing entries to a special accounting period that keeps them https://online-accounting.net/ separate from all of the other entries. So, even though the process today is slightly (or completely) different than it was in the days of manual paper systems, the basic process is still important to understand.
In addition, if the company uses several sets of books for its subsidiaries, the results of each subsidiary must first be transferred to the books of the parent company and all intercompany transactions eliminated. If the subsidiaries also use their own subledgers, then their subledgers must be closed out before the results of the units of production method subsidiaries can be transferred to the books of the parent company. Since the income summary account is only a transitional account, it is also acceptable to close directly to the retained earnings account and bypass the income summary account entirely. The income summary is a temporary account used to make closing entries.
Journalizing and Posting Closing Entries
Notice that the effect of this closing journal entry is to credit the retained earnings account with the amount of 1,400 representing the net income (revenue – expenses) of the business for the accounting period. You might be asking yourself, “is the Income Summary account even necessary? ” Could we just close out revenues and expenses directly into retained earnings and not have this extra temporary account? We could do this, but by having the Income Summary account, you get a balance for net income a second time. 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.
Starting with zero balances in the temporary accounts each year makes it easier to track revenues, expenses, and withdrawals and to compare them from one year to the next. There are four closing entries, which transfer all temporary account balances to the owner’s capital account. This is no different from what will happen to a company at the end of an accounting period. A company will see its revenue and expense accounts set back to zero, but its assets and liabilities will maintain a balance. In summary, the accountant resets the temporary accounts to zero by transferring the balances to permanent accounts.
- The closing entry will credit Dividends and debit Retained Earnings.
- The closing entries are the journal entry form of the Statement of Retained Earnings.
- When you compare the retained earnings ledger (T‑account) to the statement of retained earnings, the figures must match.
For each temporary account there will be a closing journal entry. Temporary (nominal) accounts are accounts that are closed at the end of each accounting period, and include income statement, dividends, and income summary accounts. These accounts are temporary because they keep their balances during the current accounting period and are set back to zero when the period ends.
From this trial balance, as we learned in the prior section, you make your financial statements. After the financial statements are finalized and you are 100 percent sure that all the adjustments are posted and everything is in balance, you create and post the closing entries. The closing entries are the last journal entries that get posted to the ledger. Permanent (real) accounts are accounts that transfer balances to the next period and include balance sheet accounts, such as assets, liabilities, and stockholders’ equity. These accounts will not be set back to zero at the beginning of the next period; they will keep their balances.
The balance in dividends, revenues and expenses would all be zero leaving only the permanent accounts for a post closing trial balance. 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, 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. A temporary account is an income statement account, dividend account or drawings account. At the end of the accounting period, the balance is transferred to the retained earnings account, and the account is closed with a zero balance.
Clear the balance of the revenue account by debiting revenue and crediting income summary. The next and final step in the accounting cycle is to prepare one last post-closing trial balance. Understanding the accounting cycle and preparing trial balances is a practice valued internationally.