A closing entry is a critical step in the accounting cycle that helps businesses wrap up an accounting period by transferring balances from temporary accounts to permanent ones. If you’re wondering what are closing entries, or how to perform them correctly, this guide will walk you through everything—including examples, journal entries, and the role of the income summary.
What Is a Closing Entry?
In accounting, a closing entry is a journal entry made at the end of an accounting period to reset all temporary account balances to zero. These entries transfer the balances from income statement accounts—like revenue, expenses, and dividends—to permanent balance sheet accounts such as retained earnings.
Closing entries ensure that all temporary accounts, such as revenues and expenses, are reset—allowing the new accounting period to start fresh with accurate financial tracking. Post-closing entries are finalized only after these transfers are complete.
Why Are Closing Entries Important?
- They summarize the financial performance of the business during a specific accounting period.
- They reset temporary accounts (revenue, expenses, and dividends) for the next period.
- They update the retained earnings account, reflecting net income or loss.
- They provide a clear audit trail when using the income summary closing entry method.
Temporary Accounts vs. Permanent Accounts
| Temporary Accounts | Permanent Accounts |
|---|---|
| Revenue | Assets |
| Expenses | Liabilities |
| Dividends | Retained Earnings |
| Reset every period | Carried forward continuously |
In closing entries accounting, temporary accounts in accounting—like revenues and expenses—track financial activity for a set period and are closed at the end of that period. In contrast, permanent accounts like assets and liabilities, which appear on the balance sheet, are not affected by closing entries and continue to carry their balances forward into the next accounting period.
Understanding the Income Summary Closing Entry
Instead of transferring temporary account balances directly into retained earnings, many companies first move them into an income summary account. This intermediate step allows for easier tracking and reviewing before the final transfer.
Steps:
- Close revenue accounts → Debit revenue, credit income summary.
- Close expense accounts → Debit income summary, credit expenses.
- Transfer net income → Credit income summary, debit retained earnings.
- Close dividends → Debit retained earnings, credit dividends.
If the company has a net loss, the retained earnings are debited, and income summary is credited.
How to Journalize a Closing Entry
Here’s a closing entries example to illustrate:
Assume a business has:
- Revenues: $10,000
- Expenses: $6,000
- Dividends: $1,000
Step-by-step Closing Journal Entries:
Close revenue to income summary:
| Account | Debit ($) | Credit ($) |
|---|---|---|
| Revenue | 10,000 | |
| Income Summary | 10,000 |
Close expenses to income summary:
| Account | Debit ($) | Credit ($) |
|---|---|---|
| Income Summary | 6,000 | |
| Expenses | 6,000 |
Transfer net income to retained earnings:
| Account | Debit ($) | Credit ($) |
|---|---|---|
| Income Summary | 4,000 | |
| Retained Earnings | 4,000 |
Close dividends to retained earnings:
| Account | Debit ($) | Credit ($) |
|---|---|---|
| Retained Earnings | 1,000 | |
| Dividends | 1,000 |
When Do Post-Closing Entries Start?
Post-closing entries are recorded once all closing entries have been completed and all temporary accounts are cleared. At this stage, only permanent accounts remain active, marking the start of a new accounting period.
Special Considerations in Closing Entries Accounting
- Modern accounting software (like QuickBooks or SAP) automates the closing process.
- If you’re using manual accounting, you must carefully follow the journal entry sequence to avoid errors.
- Always confirm the retained earnings normal balance—which is typically a credit—to ensure your entries are correct.
FAQs on Closing Entry and Related Topics
❓ How to close revenue accounts?
Each revenue account is closed by debiting the revenue and crediting the income summary, which is a key step in preparing the income summary closing entry during the closing entries accounting process.
❓ Is retained earnings a debit or credit?
Retained earnings normally have a credit balance, increasing with net income and decreasing with dividends or losses.
❓ What is the closing inventory journal entry?
Closing inventory is usually not a part of closing entries. Instead, it’s adjusted through cost of goods sold and inventory accounts before period close.