Closing Entries

Closing entries are the journal entries which are made at the end of an accounting year to transfer the balance from temporary accounts to permanent accounts. In other words, we post-closing entries to reset the balance in all temporary accounts to zero. This is to ensure that these temporary accounts have zero balance at the beginning of the next accounting year.

Temporary Accounts

Temporary accounts are income statement accounts that we use to record transactions and track accounting activity during an accounting period. The balances in these accounts do not roll over to the next year. E. g, we use the revenues account to record the revenues of the business for an accounting period and not for the whole life of the business. Since no business will want to carry forward the amount in revenue account of FY 2015 to FY 2016. So, we call these accounts to be temporary accounts.

All income statement accounts are temporary accounts. Examples include interest account, depreciation account, sales account, rent expense account, salary expense account, etc. The balance in these accounts shows the financial performance of a business for some time which is, the accounting year. Hence, there is no sense in an income statement account, such as salary expense account, carrying the balance of previous year’s salary expense incurred. The previous year’s salary relates to the performance of the business in the previous year and not the current year.

For this reason, income statement accounts are temporary accounts and we bring down the balance in them down to nil before the start of the next accounting year.

Permanent Accounts

Permanent accounts are the balance sheet accounts, the balance of which exist for a period longer than one year or the current accounting year. In permanent accounts, the ending balance of this year will be the beginning balance for the next year. E.g. a vehicle account is a permanent account since you will enjoy the benefits of a vehicle for the years to come and won’t through it away after the end of the current year. Likewise, you will keep using all the assets in your balance sheet and will be obliged to pay all the liabilities beyond the current year. For these reasons, balance sheet accounts are permanent accounts.

Transferring the Balance

The balance of all temporary accounts can either be directly transferred to the Retained Earnings account or through an intermediate account called the Income summary account. The income summary account is also a temporary account which soaks/absorbs the balances of the all the temporary accounts of the income statement and then transfers the ‘net’ of these amounts to the retained earnings account. This net amount in the income summary account is equal to the net income for the period shown by the income statement.

If you use an income summary account to transfer balances from the temporary accounts to the permanent accounts, four closing entries are made:

  1. Closing Entry for Revenues and Gains Accounts

The total revenues (from sales) and other gains (say, from selling machinery at profit) at the end of the accounting period are transferred to the income summary account. The objective is that the revenue and gains account should begin with a zero balance in the following accounting year.

The journal entry will be:

 

DateParticularsDebit ($)Credit ($)
March 31, 2019Revenue and gains account

Income summary account

(To record purchase of a new vehicle)

 — 

 

  1. Closing Entry for all the Expenses and Losses Accounts

Just like revenue and gains account, all the expenses and losses are also transferred to the income summary account so that the balance in them is nil at the start of the next accounting year.

The journal entry will be:

 

DateParticularsDebit ($)Credit ($)
March 31, 2019Income summary account

Cost of Goods Sold account

Depreciation expense account

Rent expense account

Salary expense account

Interest expense account

Other expenses account

(To record transfer of expenses to income summary account)

 — 

Closing Entries

  1. Closing Entry for the Income Summary Account

The next step is to close the income summary account by transferring the net balance, or the difference between the income and the expenses, to the retained earnings account. In case of a profit, the income summary account will be debited, and the retained earnings account will be credit. The journal entry will be:

 

DateParticularsDebit ($)Credit ($)
March 31, 2019Income summary account

Retained Earnings account

(To record transfer of income summary account balance to retained earnings)

 — 

 

  1. Closing Entry for the Dividend Account

After calculating the net profit and transferring the balance to the retained earnings, we close the dividend account. The need to close the dividend account arises only if the company decides to pay dividends in that accounting year. The journal entry will be:

 

DateParticularsDebit ($)Credit ($)
March 31, 2019Retained earnings account

Dividend account

(To record transfer of dividend account)

 — 

All these 4 entries are collectively known as closing entries.

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Liberto D. Closing Entry Definition. Investopedia. May 2019. [Source]
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Closing Entry – Definition, Explanation, and Examples. Corporate Finance Institute. August 2019. [Source]
3.
Closing Entries | Types | Example | My Accounting Course. My Accounting Course. August 2019. [Source]
4.
Closing entries —  AccountingTools. AccountingTools. January 2019. [Source]
Last updated on : August 21st, 2019
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