How to Properly Close Revenue Accounts

Revenue accounts represent the total income generated by a business from its primary operations over a specific period. These accounts are fundamental in financial reporting, capturing the inflow of economic benefits that increase equity. Properly closing these accounts at the end of an accounting cycle is a standard and necessary procedure. This process ensures that financial records are accurately prepared for the subsequent reporting period.

Understanding Temporary Accounts

Temporary accounts, sometimes referred to as nominal accounts, accumulate financial activity for a defined accounting period. Revenue accounts fall into this category, alongside expense and dividend accounts. Unlike permanent accounts, which include assets, liabilities, and equity, temporary accounts do not carry balances forward from one period to the next.

Balances in temporary accounts reflect activity over a fiscal year, quarter, or month. At the close of each period, these accounts must be reset to a zero balance. This resetting is crucial for ensuring that financial statements accurately represent the new accounting period’s performance. For example, a revenue account accumulates sales income earned from the first day to the last day of a period, and then its balance is cleared before the next period begins.

The Closing Process for Revenue Accounts

Closing revenue accounts involves transferring their accumulated balances to an intermediary account called Income Summary. This process effectively reduces the balance of each revenue account to zero, making it ready to record new revenues in the next accounting period. The initial step requires debiting each individual revenue account for its full balance. Simultaneously, the total of all these debits is credited to the Income Summary account.

For instance, if a business has a “Sales Revenue” account with a $50,000 credit balance and a “Service Revenue” account with a $20,000 credit balance, the journal entry would involve debiting Sales Revenue for $50,000, debiting Service Revenue for $20,000, and crediting Income Summary for $70,000. This action moves the entire revenue earned during the period into a single temporary holding account. The Income Summary account then contains the net effect of all temporary accounts, including expenses, reflecting the period’s net income or loss.

After all revenue and expense accounts have been closed to the Income Summary account, the balance of the Income Summary account itself is closed. If the business generated a net income, the Income Summary account will have a credit balance. This credit balance is then transferred to a permanent equity account. For corporations, this account is Retained Earnings, while for sole proprietorships or partnerships, it would be the Owner’s Capital account.

The journal entry to close the Income Summary account when there is a net income involves debiting Income Summary for its credit balance and crediting the appropriate equity account. For example, if Income Summary has a $30,000 credit balance, the entry would be a debit to Income Summary for $30,000 and a credit to Retained Earnings for $30,000. Conversely, a net loss would result in a debit balance in Income Summary, requiring a credit to Income Summary and a debit to the equity account to reduce it.

Verifying Account Closure

After completing all closing entries, the next step is to verify that all temporary accounts, including revenue accounts, have been properly closed and have zero balances. This verification is performed by preparing a post-closing trial balance. This trial balance is prepared after all closing entries have been posted to the general ledger.

The post-closing trial balance should only list permanent accounts, such as assets, liabilities, and equity accounts. The absence of any revenue, expense, or dividend accounts on this trial balance confirms that they have been reset to zero. This final check ensures the accuracy of the closing process and confirms that the ledger is prepared for the recording of transactions in the upcoming accounting period.