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 https://online-accounting.net/ and examples for business. Now for this step, we need to get the balance of the Income Summary account. In step 1, we credited it for $9,850 and debited it in step 2 for $8,790.

Although the drawings account is not an income statement account, it is still classified as a temporary account and needs a closing journal entry to zero the balance for the next accounting period. Closing journal entries are used at the end of the accounting cycle to close the temporary accounts for the accounting period, and transfer the balances to the retained earnings account. First, all the various revenue account balances are transferred to the temporary income summary account. This is done through a journal entry that debits revenue accounts and credits the income summary. Closing your accounting books consists of making closing entries to transfer temporary account balances into the business’ permanent accounts.

Step 2: Close all expense accounts to Income Summary

Take note that closing entries are prepared only for temporary accounts. 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). The retained earnings account is reduced by the amount paid out in dividends through a debit, and the dividends expense is credited. The net result of these activities is to move the net profit or net loss for the period into the retained earnings account, which appears in the stockholders’ equity section of the balance sheet.

This trial balance gives the opening balances for the next accounting 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. At the start of the new accounting period, the closing balance from the previous accounting period is brought forward and becomes the new opening balance on the account. Other than the retained earnings account, closing journal entries do not affect permanent accounts. A sole proprietor or partnership often uses a separate drawings account to record withdrawals of cash by the owners.

Clear the balance of the revenue account by debiting revenue and crediting income summary. Now, it’s time to close the income summary to the retained earnings (since how to create a cash flow projection we’re dealing with a company, not a small business or sole proprietorship). This time period, called the accounting period, usually reflects one fiscal year.

Closing entries Closing procedure

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. 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.

Income and expenses are closed to a temporary clearing account, usually Income Summary. Afterwards, withdrawal or dividend accounts are also closed to the capital account. 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.

Unit 4: Completion of the Accounting Cycle

In partnerships, a compound entry transfers each partner’s share of net income or loss to their own capital account. In corporations, income summary is closed to the retained earnings account. After the closing journal entry, the balance on the dividend account is zero, and the retained earnings account has been reduced by 200. Suppose a business had the following trial balance before any closing journal entries at the end of an accounting period.

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. 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.

What Does Closing Entry Mean?

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. Adjusting entries are used to modify accounts so that they’re in compliance with the accrual concept of recording income and expenses.

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. All of these entries have emptied the revenue, expense, and income summary accounts, and shifted the net profit for the period to the retained earnings account. 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.

Step #2: Close Expense Accounts

Such periods are referred to as interim periods and the accounts produced as interim financial statements. 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). For corporations, Income Summary is closed entirely to « Retained Earnings ».

• If a company’s revenues are greater than its expenses, the closing entry entails debiting income summary and crediting retained earnings.
• Closing entries is the step before preparing the post-closing trial balance, which consists temporary accounts only like assets, liabilities, and equity accounts.
• All drawing accounts are closed to the respective capital accounts at the end of the accounting period.
• Closing journal entries is done before the preparation of the post-closing trial balance, which consists the company’s permanent accounts only like asset, liability, and equity.
• The income and expenses accounts, on the other hand, will have a zero ending balance and will start the next year with a zero balance.
• Take note that closing entries are prepared only for temporary accounts.

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. 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. Clear the balance of the expense accounts by debiting income summary and crediting the corresponding expenses.

One more step…

After preparing the closing entries above, Service Revenue will now be zero. 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. After this closing entry has been posted, each of these revenue accounts has a zero balance, whereas the Income Summary has a credit balance of $7,400.