Now for this step, we need to get the balance of the Income Summary account. In step 1, we credited it for $9,850 and debited it in step 2 for $8,790. To close that, we debit Service Revenue for the full amount and credit Income Summary for the same. Whether you’re processing closing entries manually, or letting your accounting software do the work, closing entries are perhaps the most important part of the accounting cycle.
Doing this would bring the balances of the Expenses Account to zero. We have completed the first two columns and now we have the final column which represents the closing (or archive) process. Notice that the balance of the Income Summary account is actually the net income for the period. Remember that net income is equal to all income minus all expenses.
Using Income Summary in Closing Entries
The purpose of closing entries is to merge your accounts so you can determine your retained earnings. Retained earnings represent the amount your business owns after paying expenses and dividends for a specific time period. Only income statement accounts help us summarize income, so only income statement accounts should go into income summary.
In summary, the accountant resets the temporary accounts to zero by transferring the balances to permanent accounts. Accountants may perform the closing process monthly or annually. The closing entries are the journal entry form of the Statement of Retained Earnings. Closing entries are journal entries used to empty temporary accounts at the end of a reporting period and transfer their balances into permanent accounts.
- Only balance sheet accounts are included in the post-closing trial balance and are prepared at the end of the accounting cycle.
- Notice that the balances in the expense accounts are now zero and are ready to accumulate expenses in the next period.
- Income and expenses are closed to a temporary clearing account, usually Income Summary.
- The balance in dividends, revenues and expenses would all be zero leaving only the permanent accounts for a post closing trial balance.
- We know the change in the balance includes net income and dividends.
- The Income Summary account has a new credit balance of $4,665, which is the difference between revenues and expenses in Figure 1.29.
Take note that closing entries are prepared only for temporary accounts. The retained earnings account is reduced by the amount paid out in dividends through a debit, and the dividends expense is credited. Permanent accounts, on the other hand, track activities that extend beyond the current accounting period.
Closing entries help in the reconciliation of accounts which facilitates in controlling the overall financials of a firm. All accounts can be classified as either permanent (real) or temporary (nominal) the following Figure 1.27. This challenge becomes even more daunting as your business expands. Manual processes struggle to handle the increasing volume of financial transactions and complexities.
Recording a Closing Entry
To update the balance in the owner’s capital account, accountants close revenue, expense, and drawing accounts at the end of each fiscal year or, occasionally, at the end of each accounting period. For this reason, these types of accounts are called temporary or nominal accounts. When an accountant closes an account, the account balance returns to zero.
Example of a Closing Entry
Keep in mind, however, that this account is only purposeful for closing the books, and thus, it is not recorded into any accounting reports and has a zero balance at the end of the closing process. After most of the cycle is completed and financial statements are generated, there’s one last step in the process known as closing your books. The income statement summarizes your income, as does income summary. If both summarize your income in the same period, then they must be equal.
Temporary and Permanent Accounts
The fourth entry requires Dividends to close to the Retained Earnings account. Remember from your past studies that dividends are not expenses, such as salaries paid to your employees or staff. Instead, declaring and paying dividends is a method utilized by corporations free wave accounting alternative to return part of the profits generated by the company to the owners of the company—in this case, its shareholders. Companies are required to close their books at the end of each fiscal year so that they can prepare their annual financial statements and tax returns.
Corporations will close the income summary account to the retained earnings account. Closing entries are completed at the end of each accounting period after your adjusted trial balance has been run. One of the most important steps in the accounting cycle is creating and posting your closing entries.
What Is a Closing Entry?
The second entry requires expense accounts close to the Income Summary account. To get a zero balance in an expense account, the entry will show a credit to expenses and a debit to Income Summary. Printing Plus has $100 of supplies expense, $75 of depreciation expense–equipment, $5,100 of salaries expense, and $300 of utility expense, each with a debit balance on the adjusted trial balance. The closing entry will credit Supplies Expense, Depreciation Expense–Equipment, Salaries Expense, and Utility Expense, and debit Income Summary.
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