What Does a Closing Entry Look Like?

Closing entries are journal entries made at the end of an accounting period to prepare a company’s financial records for the next period. They transfer the balances of temporary accounts to permanent accounts.

This process is a step within the accounting cycle, ensuring each new period begins with a clean slate for certain accounts. This allows for accurate measurement of performance over specific timeframes.

Understanding Temporary Accounts

Understanding closing entries requires distinguishing between temporary and permanent accounts. Permanent accounts, including assets, liabilities, and equity, carry their balances over from one accounting period to the next. These accounts reside on the balance sheet and provide an ongoing snapshot of a company’s financial position.

Temporary accounts track financial activity for a single accounting period. They include revenue accounts, expense accounts, and drawing accounts. Revenue accounts track income, while expense accounts record costs. Drawing accounts track distributions of earnings to owners. Temporary accounts are reset to zero at the end of each accounting period, preventing the mixing of financial performance data across different periods.

The Steps to Closing Accounts

The process of closing accounts involves four main steps to transfer temporary account balances to Retained Earnings. The first step closes all revenue accounts. Since revenue accounts normally carry a credit balance, they are debited to bring their balance to zero, with a corresponding credit to Income Summary.

The second step closes all expense accounts. Expense accounts typically have debit balances, so to reduce them to zero, each expense account is credited. The total of these expense credits is then debited to the Income Summary account.

In the third step, the balance of the Income Summary account is transferred to Retained Earnings. If Income Summary has a credit balance (net income), it is debited to zero, with a credit to Retained Earnings. If Income Summary has a debit balance (net loss), it is credited, with a debit to Retained Earnings.

The final step closes the Dividends or Drawing account. These accounts typically have a debit balance, so they are credited to zero. The corresponding debit is made to the Retained Earnings account.

Examples of Closing Entries

Here are examples of closing entries. To close a revenue account, such as Sales Revenue with a $10,000 credit balance, debit Sales Revenue and credit Income Summary.

| Date | Account | Debit | Credit |
|—|—|—|—|
| Dec 31 | Sales Revenue | $10,000 | |
| | Income Summary | | $10,000 |
| | To close revenue to Income Summary | | |

To close multiple expense accounts, like Rent Expense of $2,000 and Salaries Expense of $3,000, credit each expense account and debit Income Summary for the total.

| Date | Account | Debit | Credit |
|—|—|—|—|
| Dec 31 | Income Summary | $5,000 | |
| | Rent Expense | | $2,000 |
| | Salaries Expense | | $3,000 |
| | To close expenses to Income Summary | | |

If Income Summary has a $5,000 credit balance (net income), debit Income Summary and credit Retained Earnings.

| Date | Account | Debit | Credit |
|—|—|—|—|
| Dec 31 | Income Summary | $5,000 | |
| | Retained Earnings | | $5,000 |
| | To close net income to Retained Earnings | | |

If Income Summary has a $1,000 debit balance (net loss), credit Income Summary and debit Retained Earnings.

| Date | Account | Debit | Credit |
|—|—|—|—|
| Dec 31 | Retained Earnings | $1,000 | |
| | Income Summary | | $1,000 |
| | To close net loss to Retained Earnings | | |

To close a Dividends account with a $1,500 debit balance, debit Retained Earnings and credit Dividends.

| Date | Account | Debit | Credit |
|—|—|—|—|
| Dec 31 | Retained Earnings | $1,500 | |
| | Dividends | | $1,500 |
| | To close Dividends to Retained Earnings | | |

After Closing Entries

After all closing entries have been journalized and posted, the next step in the accounting cycle is to prepare a post-closing trial balance. This trial balance verifies that all temporary accounts—revenues, expenses, and dividends—have been reduced to a zero balance. It confirms the accounting system is prepared for the new fiscal period.

The post-closing trial balance exclusively lists permanent accounts, such as assets, liabilities, and equity, as these are the only accounts that carry balances forward. By ensuring total debits equal total credits in this trial balance, businesses can be confident in the accuracy of their financial records before commencing transactions for the next accounting period.