The assumption is that all income from the company in one year is held for future use. One such expense that's determined at the end of the year is dividends. The last closing entry reduces the amount retained by the amount paid out to investors. Temporary accounts are used to record accounting activity during a specific period. All revenue and expense accounts must end with a zero balance because they're reported in defined periods. A hundred dollars in revenue this year doesn't count as $100 in revenue for next year even if the company retained the funds for use in the next 12 months.
Step 2 – Close Expenses to the Income Summary
Suppose we have a small business, ABC Electronics, and it’s the end of the fiscal year (December 31). We need to close the temporary accounts (revenue and expenses) and transfer the net income to Retained Earnings. Closing entries play a crucial role in maintaining accurate financial records and ensuring that each accounting period’s performance is distinct. They also facilitate the creation of financial statements that provide stakeholders with a clear understanding of a company’s financial position and performance over time. In this case, if you paid out a dividend, the balance would be moved to retained earnings from the dividends account. Once this has been completed, a post-closing trial balance will be reviewed to ensure accuracy.
Trial Balance
The first part is the date ofdeclaration, which creates the obligation or liability to pay thedividend. The second part is the date of record that determines whoreceives the dividends, and the third part is the date of payment,which is the date that payments are made. Printing Plus has $100 ofdividends with a debit balance on the adjusted trial balance. Theclosing entry will credit Dividends and debit RetainedEarnings.
Interim Financial Periods
It’s vital in business to keep a detailed record of your accounts. All accounts can be classified as either permanent (real) ortemporary (nominal) (Figure5.3). For information pertaining to the registration status of 11 Financial, please contact the state securities regulators for those states in which 11 Financial maintains a registration filing. Answer the following questions on closing entries and rate your confidence to check your answer. You might not feel like an expert in closing entries just yet but you can always refer back to refresh your memory. Imagine we are doing a month-end or year-end close, we’re going to follow these steps.
The process of closing entries in accounting ensures the temporary accounts have a balance of zero at the end of the period. The funds must be transferred into another account, the income summary account, to bring each account balance down to zero. The expense accounts have debit balances so to get rid of their balances we will do the opposite or credit the accounts. Just like in step 1, we will use Income Summary as the offset account but this time we will debit income summary. The total debit to income summary should match total expenses from the income statement.
Step 1 – Close Revenue to the Income Summary
- Using the above steps, let’s go through an example of what the closing entry process may look like.
- After the posting of this closing entry, the income summary now has a credit balance of $14,750 ($70,400 credit posted minus the $55,650 debit posted).
- With the use of modern accounting software, this process often takes place automatically.
- Having an intermediate income summary account proves helpful to the accountant here as it provides a trail of accounting closing entries for each financial transaction.
- Are the value of your assets andliabilities now zero because of the start of a new year?
A temporary account is an income statement account, dividend account or drawings account. It is temporary because it lasts only for the accounting period. At the end of the accounting period, the balance is transferred to the retained earnings account, and the account is closed with a zero balance. For each temporary account there will be a closing journal entry. Temporary (nominal) accounts are accounts thatare closed at the end of each accounting period, and include incomestatement, dividends, and income summary accounts.
Part 2: Your Current Nest Egg
In order to close out your expense accounts, you will need to debit the income summary account, and credit each line item expense listed in the trial balance, which reduces the expense account balances to zero. To begin, you want to run an adjusted trial balance, which is used to prepare your closing entries, moving both the revenue and the expense closing entries account balances, as well as drawing account and/or dividend account balances. The income summary is used to transfer the balances of temporary accounts to retained earnings, which is a permanent account on the balance sheet. Closing journal entries are made at the end of an accounting period to prepare the accounting records for the next period.
