How to Close Revenue Accounts Step by Step

Closing revenue accounts is a necessary step in the accounting cycle, ensuring a clean slate for financial reporting in each new period. This process involves transferring the balances of temporary accounts to permanent accounts. Businesses accurately reflect their financial performance and prepare for future operations by managing this process.

Identifying Revenue Accounts

Revenue accounts are general ledger accounts that record the income a company earns from its core operations, such as selling goods or providing services. They are presented at the top of the income statement, often referred to as the “top line” of a company’s financial performance. These accounts are fundamental in assessing a business’s profitability and overall financial health.

Common examples of revenue accounts include Sales Revenue, Service Revenue, Interest Revenue, and Rent Income. These accounts are considered “temporary” because they accumulate balances only for a single accounting period. At the end of each period, their balances must be reset to zero, ensuring accurate period-over-period comparison. In contrast, permanent accounts, such as assets, liabilities, and equity, carry their balances forward into the next period without being closed.

Journalizing the Closing Entry for Revenue

The process of closing revenue accounts begins with a journal entry to reset their balances to zero. Since revenue accounts carry a credit balance when they increase, reducing them to zero requires a debit entry. The corresponding credit for this entry is made to a temporary clearing account known as Income Summary. This action transfers the total revenue earned during the period into the Income Summary account.

For instance, if a business recorded $10,000 in Sales Revenue for the accounting period, the journal entry to close this account would involve debiting Sales Revenue for $10,000 and crediting Income Summary for the same amount. This entry is dated as of the last day of the accounting period. The narration for this entry would state “To close revenue accounts to Income Summary.” This step consolidates all earnings into the Income Summary account.

Closing the Income Summary Account

After all revenue and expense accounts have been closed, the Income Summary account holds the net result of the period’s operations. This account is a temporary holding account used during the closing process. Its balance represents the net income (if revenues exceeded expenses) or net loss (if expenses exceeded revenues) for the period.

The next step involves closing the Income Summary account by transferring its balance to a permanent equity account. If the Income Summary account has a credit balance, indicating net income, it is debited to bring its balance to zero. The corresponding credit is made to Retained Earnings for corporations or Owner’s Capital for sole proprietorships and partnerships. Conversely, if the Income Summary account has a debit balance, signaling a net loss, it is credited to zero out, and Retained Earnings or Owner’s Capital is debited. This entry updates the business’s equity to reflect the period’s profitability or loss.

Preparing a Post-Closing Trial Balance

The final step in the accounting cycle is to prepare a post-closing trial balance. The purpose of this report is to verify that all temporary accounts, including revenue accounts, have been reset to zero. It also confirms that the total debits equal the total credits for the remaining permanent accounts, ensuring the accounting system is balanced and ready for the next accounting period.

This trial balance will only list permanent accounts, such as assets, liabilities, and equity accounts, because all temporary accounts have had their balances transferred out. The absence of revenue, expense, and other temporary accounts on this trial balance confirms their closure. This step acts as a final check, helping to detect any errors and providing a clean set of books to begin recording transactions for the new fiscal period.