In addition, if the accounting system uses subledgers, it must close out each subledger for the month prior to closing the general ledger for the entire company. If the subsidiaries also use their own subledgers, then their subledgers must be closed out before the results of the subsidiaries can be transferred to the books of the parent company. Since the income summary account is only a transitional account, it is also acceptable to close directly to the retained earnings account and bypass the income summary account entirely. The net result of these activities is to move the net profit or net loss for the period into the retained earnings account, which appears in the stockholders' equity section of the balance sheet.
- You might be asking yourself, “is the Income Summary account
even necessary? - Our program is specifically developed for you to easily set up your closing process and initiate book closing within seconds – no prior technical knowledge necessary.
- The revenue and expense accounts should start at zero each period because we are measuring how much revenue is earned and expenses incurred during the period.
- Afterwards, withdrawal or dividend accounts are also closed to the capital account.
- Closing all temporary accounts to the income summary account leaves an audit trail for accountants to follow.
This means that the current balance of these accounts is zero, because they were closed on December 31, 2018, to complete the annual accounting period. Closing entries, on the other hand, are entries that close temporary ledger accounts and transfer their balances to permanent accounts. 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. Temporary account balances can either be shifted directly to the retained earnings account or to an intermediate account known as the income summary account beforehand.
The balances of these accounts are eventually used to construct the income statement at the end of the fiscal year. Only income
statement accounts help us summarize income, so only income
statement accounts should go into income summary. Notice that the balances in interest revenue and service revenue
are now zero and are ready to accumulate revenues in the next
period. The Income Summary account has a credit balance of $10,240
(the revenue sum). Our discussion here begins with journalizing and posting the
closing entries (Figure
5.2).
What are Closing Entries?
However, your business is also free to handle closing entries monthly, quarterly, or every six months. The retained earnings account is reduced by the amount paid out in dividends through a debit, and the dividends expense is credited. Close the income summary account by debiting income summary and crediting retained earnings. To close the drawing account to the capital account, we credit the drawing account and debit the capital account.
The Retained Earnings account balance
is currently a credit of $4,665. Printing Plus has a $4,665 credit balance in its Income Summary
account before closing, so it will debit Income Summary and credit
Retained Earnings. It is the end of the year,
December 31, 2018, and you are reviewing your financials for the
entire year. You see that you earned $120,000 this year in revenue
and had expenses for rent, electricity, cable, internet, gas, and
food that totaled $70,000. We’ll use a company called MacroAuto that creates and installs specialized exhaust systems for race cars.
Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years. He is the sole author of all the materials on AccountingCoach.com. Now, if you’re new to accounting, you probably have a ton of questions.
It is also possible to bypass the income summary account and simply shift the balances in all temporary accounts directly into the retained earnings account at the end of the accounting period. Notice that the balances in the expense accounts are now zero and are ready to accumulate expenses in the next period. The Income Summary account has a new credit balance of $4,665, which is the difference between revenues and expenses (Figure 5.5). The balance in Income Summary is the same figure as what is reported on Printing Plus’s Income Statement.
Step 4: Transfer Balance
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. Starting with zero balances in the temporary accounts each year makes it easier to track revenues, expenses, and withdrawals and to compare them from one year to the next. There are four closing entries, which transfer all temporary account balances to the owner's capital account. A closing entry is a journal entry made at the end of accounting periods that involves shifting data from temporary accounts on the income statement to permanent accounts on the balance sheet. Temporary accounts include revenue, expenses, and dividends, and these accounts must be closed at the end of the accounting year.
Permanent versus Temporary Accounts
All temporary accounts must be reset to zero at the end of the accounting period. To do this, their balances are emptied into the income summary account. The income summary account then transfers the net balance of all the temporary accounts to retained earnings, which is a permanent account on the balance sheet. Companies use closing entries to reset the balances of temporary accounts − accounts that show balances over a single accounting period − to zero.
One more step…
Closing journal entries are made at the end of an accounting period to prepare the accounting records for the next period. They zero-out the balances of temporary accounts during the current period to come up with fresh slates for the transactions in the next period. In some cases, accounting software might automatically handle the transfer of balances to an income summary account, once the user closes the accounting period.
By doing so, the company moves these balances into permanent accounts on the balance sheet. These permanent accounts show a company’s long-standing financials. Many students who enroll in an introductory accounting course do not plan to become accountants. They will work in a variety of jobs in the business field, including managers, sales, and finance. Accounting software can perform such tasks as posting the journal entries recorded, preparing trial balances, and preparing financial statements. Students often ask why they need to do all of these steps by hand in their introductory class, particularly if they are never going to be an accountant.
Overview: What are closing entries?
This balance is then transferred to the Retained
Earnings account. What is the current book value of
your electronics, home office deduction car, and furniture? Are the value of your assets and
liabilities now zero because of the start of a new year?
What is the closing entry process?
Now, it’s time to close the income summary to the retained earnings (since we’re dealing with a company, not a small business or sole proprietorship). The income summary is a temporary account used to make closing entries. To close expenses, we simply credit the expense accounts and debit Income Summary.
These journal entries are made after the financial statements have been prepared at the end of the accounting year. A closing entry also transfers the owner's drawing account (a temporary balance sheet account) balance to the owner's capital account. The closing entries will mean that the temporary accounts (income statement accounts and drawing account) will start the new accounting year with zero balances. The closing process is carried out with several journal entries, known as closing entries. These entries, which are made in the journal and posted to the ledger, eliminates the balances in all temporary accounts and transfer those balances to the retained earnings account. The usual practice is one entry is made for revenue, one for expenses and a final entry for dividends.