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. 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.
By doing so, the company moves these balances into permanent accounts on the balance sheet. The closing entries are the journal entry form of the Statement of Retained Earnings. 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. The information needed to prepare closing entries comes from the adjusted trial balance.
Here we need to debit retained earnings account and credit dividends account. Clear the balance of the expense accounts by debiting income summary and crediting the corresponding expenses. 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. 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.
- 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 income statement summarizes your income, as does income summary.
- To determine the income (profit or loss) from the month of January, the store needs to close the income statement information from January 2019.
- Here Bob needs to debit retained earnings account and credit dividends account.
- Some common examples of closing entries include the closing of revenue accounts, expense accounts, and dividend accounts.
If dividends are declared, to get a zero balance in the Dividends account, the entry will show a credit to Dividends and a debit to Retained Earnings. As you will learn in Corporation Accounting, there are three components to the declaration and payment of dividends. The first part is the date of declaration, which creates the obligation or liability to pay the dividend.
Example of a Closing Entry
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. 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. As an another example, you should shift any balance in the dividends paid account to the retained earnings account, which reduces the balance in the retained earnings account.
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. 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. The credit to income summary should equal the total revenue from the income statement.
Introduction to the Closing Entries
All temporary accounts must be reset to zero at the end of the accounting period. To do this, their balances are emptied into the income summary account. The income summary account then transfers the net balance of all the temporary accounts to retained earnings, which is a permanent account on the balance sheet. The statement of retained earnings shows the period-ending retained earnings after the closing entries have been posted. When you compare the retained earnings ledger (T-account) to the statement of retained earnings, the figures must match.
- This will ensure that the balances of the revenue account are transferred to the income summary account.
- The accountant can choose either method as eventually all the accounts will be transferred to the retained earnings account on the balance sheet.
- The income summary account then transfers the net balance of all the temporary accounts to retained earnings, which is a permanent account on the balance sheet.
- By doing so, companies move the temporary account balances to the permanent accounts of the balance sheet.
- On the balance sheet, $75 of cash held today is still valued at $75 next year, even if it is not spent.
This is contrary to what is normally done, as Bob has made a net loss for the period. Therefore, this entry will ensure that the balance has been transferred on the balance sheet. To close the revenue accounts for Bob’s Donut Shoppe, we need to debit the revenue account and credit the income summary account.
15 Closing Entries
Carbon Collective partners with financial and climate experts to ensure the accuracy of our content. From the above entry, we can see that Bob had made $3,600 in revenue for January 2020. We also have an accompanying spreadsheet which shows you an example of each step.