You have also not incurred any expenses yet for rent, electricity, cable, internet, gas or food. This means that the current balance of these accounts is zero, because they were closed on December 31, 2018, to complete the annual accounting period. Closing entries occur at the end of an accounting year to transfer the balances in the temporary accounts to a permanent or real account. The intended result is for each temporary account to begin the next accounting year with a zero balance. Close the income summary account by debiting income summary and crediting retained earnings.

Having a zero balance in these accounts is important so a company can compare performance across periods, particularly with income. 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. If a company’s revenues are greater than its expenses, the closing entry entails debiting income summary and crediting retained earnings.

Understanding Closing Entries

The total debit to income summary should match total expenses from the income statement. The temporary accounts include the income statement accounts (revenue, expense, gain, loss, income summary) and also the drawing account of a sole proprietorship. The balances in these accounts will ultimately end up in the sole proprietor’s capital account or the corporation’s retained earnings account. A sole proprietor https://online-accounting.net/ or partnership often uses a separate drawings account to record withdrawals of cash by the owners. 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. This means that it is not an asset, liability, stockholders’ equity, revenue, or expense account.

Accounts payable form the largest portion of the current liability section on the company’s financial statements. Below are the T accounts with the journal entries already posted. We’ll use a company called MacroAuto that creates and installs specialized exhaust systems for race cars. Here are MacroAuto’s accounting records simplified, using positive numbers for increases and negative numbers for decreases instead of debits and credits in order to save room and to get a higher-level view. Notice that the Income Summary account is now zero and is ready for use in the next period.

Journal entries for Accounts Payable:

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All accounts can be classified as either permanent (real) or temporary (nominal) (Figure 5.3). Answer the following questions on closing entries and rate your confidence to check your answer. We have completed the first two columns and now we have the final column which represents the closing (or archive) process.

Looking To Get Started?

The purpose of the closing entries is to end up with a zero balance in every temporary account before starting the next accounting year. 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. Instead, declaring and paying dividends is a method utilized by corporations to return part of the profits generated by the company to the owners of the company—in this case, its shareholders.

• Other than the retained earnings account, closing journal entries do not affect permanent accounts.
• Companies use closing entries to reset the balances of temporary accounts − accounts that show balances over a single accounting period − to zero.
• Therefore, these accounts still have a balance in the new year, because they are not closed, and the balances are carried forward from December 31 to January 1 to start the new annual accounting period.
• Steps 1 through 4 were covered in Analyzing and Recording Transactions and Steps 5 through 7 were covered in The Adjustment Process.
• 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.

However, most companies prepare monthly financial statements and close their books annually, so they have a clear picture of company performance during the year, and give users timely information to make decisions. Accounts payable is on account of purchases being made on the account. The purchases are expenses items on the debit side of the income statement shown as the cost of goods sold. The nature of accounts payable is that of a permanent nature account. That means it would have a balance at the end of the year and be shown in the balance sheet.

Financial Accounting

The Retained Earnings account balance is currently a credit of $4,665. Printing Plus has a $4,665 credit balance in its Income Summary account before closing, so it will debit Income Summary and credit Retained Earnings. The business has been operating for several years but does not have the resources for accounting software. This means you are preparing all steps in the accounting cycle by hand. In this chapter, we complete the final steps (steps 8 and 9) of the accounting cycle, the closing process.

The third entry closes the Income Summary account to Retained Earnings. The fourth entry closes the Dividends account to Retained Earnings. The information needed to prepare closing entries comes from the adjusted trial balance. To further clarify this concept, balances are closed to assure all revenues and expenses are recorded in the proper period and then cash flow from financing activities 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.

Step 2: Close Expense accounts

Remember, modern computerized accounting systems go through this process in preparing financial statements, but the system does not actually create or post journal entries. A net loss would decrease owner’s capital, so we would do the opposite in this journal entry by debiting the capital account and crediting Income Summary. The remaining balance in Retained Earnings is $4,565 (Figure 5.6). This is the same figure found on the statement of retained earnings. The next day, January 1, 2019, you get ready for work, but before you go to the office, you decide to review your financials for 2019. What are your total expenses for rent, electricity, cable and internet, gas, and food for the current year?

The Philippines Center for Entrepreneurship and the government of the Philippines hold regular seminars going over this cycle with small business owners. They are also transparent with their internal trial balances in several key government offices. Check out this article talking about the seminars on the accounting cycle and this public pre-closing trial balance presented by the Philippines Department of Health. 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. It is not an income statement item in which accountants close at the end of each accounting period.