These accounts are temporary because they keep their balances during the current accounting period and are set back to zero when the period ends. Revenue and expense accounts are closed to Income Summary, and Income Summary and Dividends are closed to the permanent account, Retained Earnings. 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.
By doing so, the company moves these balances into permanent accounts on the balance sheet. These permanent accounts show a company’s long-standing financials. 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.
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. Closing your accounting books consists of making closing entries to transfer temporary account balances into the business’ permanent accounts. Examples of temporary accounts are the revenue, expense, and dividends paid accounts. Any account listed in the balance sheet (except for dividends paid) is a permanent account.
- A temporary account accumulates balances for a single accounting period, whereas a permanent account stores balances over multiple periods.
- Temporary (nominal) accounts are accounts that
are closed at the end of each accounting period, and include income
statement, dividends, and income summary accounts. - All expense accounts are then closed to the income summary account by crediting the expense accounts and debiting income summary.
- As you will see later, Income Summary is eventually closed to capital.
- 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.
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. Whether you’re processing closing entries manually, or letting your accounting software do the work, closing entries are perhaps the most important part of the accounting cycle. If your business is a corporation, you will not have a drawing account, but if you paid stockholders, you will have a dividends account. If you paid dividends for the month, you will need to close that account as well. While these accounts remain on the books, their balance is reset to zero each month, which is done using closing entries. Let’s move on to learn about how to record closing those temporary accounts.
Purpose of Closing Entries
A company will see its revenue and expense accounts set back to zero, but its assets and liabilities will maintain a balance. Stockholders’ equity accounts will also maintain their balances. In summary, the accountant resets xero odbc driver experts the temporary accounts to zero by transferring the balances to permanent accounts. The balance in dividends, revenues and expenses would all be zero leaving only the permanent accounts for a post closing trial balance.
However, you might wonder, “Where are the revenue, expense, and dividend accounts? 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. After the posting of this closing entry, the income summary now has a credit balance of $14,750 ($70,400 credit posted minus the $55,650 debit posted). Only income statement accounts help us summarize income, so only income statement accounts should go into income summary.
- You will notice that we
do not cover step 10, reversing entries. - Closing all temporary accounts to the income summary account leaves an audit trail for accountants to follow.
- We’ll use a company called MacroAuto that creates and installs specialized exhaust systems for race cars.
- The total of the income summary account after the all temporary accounts have been close should be equal to the net income for the period.
This is the same figure found on the statement of retained earnings. This process resets both the income and expense accounts to zero, preparing them for the next accounting period. Take note that closing entries are prepared only for temporary accounts.
Closing Entries: Everything You Need to Know (+How to Post Them)
Just like in step 1, we will use Income Summary as the offset account but this time we will debit income summary. The total debit to income summary should match total expenses from the income statement. The first entry
closes revenue accounts to the Income Summary account. The second
entry closes expense accounts to the Income Summary account. The
third entry closes the Income Summary account to Retained Earnings.
On the statement of retained earnings, we reported the
ending balance of retained earnings to be $15,190. We need to do
the closing entries to make them match and zero out the temporary
accounts. The remaining balance in Retained Earnings is $4,565 (Figure 5.6).
You can do this by debiting the income summary account and crediting your capital account in the amount of $250. This reflects your net income for the month, and increases your capital account by $250. We see from the adjusted trial balance that our revenue account has a credit balance. To make the balance zero, debit the revenue account and credit the Income Summary account.
Temporary and Permanent Accounts
However, if the company also wanted to keep year-to-date information from month to month, a separate set of records could be kept as the company progresses through the remaining months in the year. For our purposes, assume that we are closing the books at the end of each month unless otherwise noted. If your expenses for December had exceeded your revenue, you would have a net loss.
Step 3: Closing the income summary account
If both summarize your income in the same period, then they must be equal. Notice how only the balance in retained earnings has changed and it now matches what was reported as ending retained earnings in the statement of retained earnings and the balance sheet. Because you paid dividends, you will need to reduce your retained earnings account, which is what this entry accomplishes. For sole proprietorships and partnerships, you’ll close your drawing account to your capital account, because you will need to reduce your capital account by the draws taken for the month. This transaction increases your capital account and zeros out the income summary account.
Now, the income summary account has a zero balance, whereas net income for the year ended appears as an increase (or credit) of $14,750. 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. 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.
To close the drawing account to the capital account, we credit the drawing account and debit the capital account. Temporary accounts include all revenue and expense accounts, and also withdrawal accounts of owner/s in the case of sole proprietorships and partnerships (dividends for corporations). Close the income summary account by debiting income summary and crediting retained earnings. The remaining balance in Retained Earnings is
$4,565 (Figure
5.6).
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.
How to Record a Closing Entry
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. All drawing accounts are closed to the respective capital accounts at the end of the accounting period.
Delivered as SaaS, our solutions seamlessly integrate bi-directionally with multiple systems including ERPs, HR, CRM, Payroll, and banks. Do you want to learn more about debit, credit entries, and how to record your journal entries properly? Then, head over to our guide on journalizing transactions, with definitions and examples for business. 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. Thus, the income summary temporarily holds only revenue and expense balances.