Closing Entries: Step by Step Guide

We now close the Distributions account to Retained Earnings. Distributions has a debit balance so we credit the account to close it. Our debit, reducing the balance in the account, is Retained Earnings. Often confused with income statements, the two are very different and should not be interpreted as being the other. The key similarity is that they both report total nets and losses.

Income Summary Account

The following video summarizes how to prepare closing entries. We have completed the first two columns and now we have the final column which represents the closing (or archive) process. The third entry requires Income Summary to close to the Retained Earnings account. To get a zero balance in the Income Summary account, there are guidelines to consider.

Four Steps in Preparing Closing Entries

The post-closing T-accounts will be transferred to the post-closing trial balance, which is step 9 in the accounting cycle. The first entry closes revenue accounts to the Income Summary account. The second entry closes expense accounts to the Income Summary account. The third entry closes the Income Summary account to Retained Earnings. The fourth entry closes the Dividends account to Retained Earnings. The information needed to prepare closing entries comes from the adjusted trial balance.

1. When the accounting period ends, all the expense accounts are closed when the debit balance transfers into the income statement.
2. Likewise, shifting expenses out of the income statement requires you to credit all of the expense accounts for the total amount of expenses recorded in the period, and debit the income summary account.
3. To make the balance zero, debit the revenue account and credit the Income Summary account.
4. 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.

Closing entries Closing procedure

The balance in Income Summary is the same figure as what is reported on Printing Plus’s Income Statement. We see from the adjusted trial balance sales journal entry that our revenue account has a credit balance. To make the balance zero, debit the revenue account and credit the Income Summary account.

We added it to Retained Earnings on the Statement of Retained Earnings. To add something to Retained Earnings, which is an equity account with a normal credit balance, we would credit the account. Temporary accounts include revenue, expenses and dividends. Each of these accounts must be zeroed out so that on the first day of the year, we can start tracking these balances for the new fiscal year. Remember that the periodicity principle states that financial statements should cover a defined period of time, generally one year. At the end of each accounting period, businesses prepare an income summary and an income statement.

In essence, we are updating the capital balance and resetting all temporary account balances. Income and expenses are closed to a temporary clearing account, usually Income Summary. Afterwards, withdrawal or dividend accounts are also closed to the capital account. To close expenses, we simply credit the expense https://www.quick-bookkeeping.net/ accounts and debit Income Summary. Temporary accounts include all revenue and expense accounts, and also withdrawal accounts of owner/s in the case of sole proprietorships and partnerships (dividends for corporations). This transaction increases your capital account and zeros out the income summary account.

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Thus, accumulating revenue and spending totals before the resulting profit or loss is passed through to the retained earnings account. It can, however, provide a useful audit trail by demonstrating how these aggregate amounts were carried through to retained earnings. Suppose the balance on the final account is a profit (credit balance). In that case, companies will debit the temporary account for the amount in profit and credit it to the retained earnings (a crucial part of the balance sheet). After this entry is made, all temporary accounts, including the income summary account, should have a zero balance.

The first entry requires revenue accounts close to the Income Summary account. To get a zero balance in a revenue account, the entry will show a debit to revenues and a credit to Income Summary. Printing Plus has $140 of interest revenue and $10,100 of service revenue, each with a credit balance on the adjusted trial balance.

This indicates that a profit was made because a credit balance must be debited to the income summary. To close the drawing account to the capital account, we credit the drawing account and debit the capital account. To close that, we debit Service https://www.quick-bookkeeping.net/comment-the-importance-of-accounting-comparability/ 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.

While these accounts remain on the books, their balance is reset to zero each month, which is done using closing entries. One of the most important steps in the accounting cycle is creating and posting your closing entries. Notice how only the balance in retained earnings has changed and it now matches what was reported as ending retained earnings in the statement of retained earnings and the balance sheet. Prepare the closing entries for Frasker Corp. using the adjusted trial balance provided. 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.

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). Permanent (real) accounts are accounts present value of 1 table that transfer balances to the next period and include balance sheet accounts, such as assets, liabilities, and stockholders’ equity. These accounts will not be set back to zero at the beginning of the next period; they will keep their balances.