Retained earnings represent the amount your business owns after paying expenses and dividends for a specific time period. A net loss would decrease retained earnings so we
would do the opposite in this journal entry by debiting Retained
Earnings and crediting Income Summary. Closing all temporary accounts to the income summary account leaves an audit trail for accountants to follow.
In a partnership, separate entries are made to close each partner’s drawing account to his or her own capital account. If a corporation has more than one class of stock and uses dividend accounts to record dividend payments to investors, it usually uses a separate dividend account for each class. If this is the case, the corporation’s accounting department makes a compound entry to close each dividend account to the retained earnings account. Other accounting software, such as Oracle’s PeopleSoft™, post closing entries to a special accounting period that keeps them separate from all of the other entries. So, even though the process today is slightly (or completely) different than it was in the days of manual paper systems, the basic process is still important to understand.
Expense accounts have a debit balance, so you’ll have to credit their respective balances and debit income summary in order to close them. This time period, called the accounting period, usually reflects one fiscal year. However, your business is also free to handle closing entries monthly, quarterly, or every six months. Instead allocating llc recourse debts the balances in these accounts are moved at month-end to either the capital account or the retained earnings account. It’s important to note that neither the drawing nor the dividends accounts need to be transferred to the income summary account. Corporations will close the income summary account to the retained earnings account.
If you paid dividends for the month, you will need to close that account as well. Since we credited income summary in Step 1 for $5,300 and debited income summary for $5,050 in Step 2, the balance in the income summary account is now a credit of $250. While these accounts remain on the books, their balance is reset to zero each month, which is done using closing entries. 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. Let’s move on to learn about how to record closing those temporary accounts.
Temporary Accounts:
After closing both income and revenue accounts, the income summary account is also closed. All generated revenue of a period is transferred to retained earnings so that it is stored there for business use whenever needed. At the end of an accounting period when the books of accounts are at finalization stage, some special journal entries are required to be passed. In accounting terms, these journal entries are termed as closing entries. The main purpose of these closing entries is to bring the temporary journal account balances to zero for the next accounting period, which keeps the accounts reconciled. We see from
the adjusted trial balance that our revenue accounts have a credit
balance.
The balance in Income Summary is the same figure as what
is reported on Printing Plus’s Income Statement. You might be asking yourself, “is the Income Summary account
even necessary? ” Could we just close out revenues and expenses
directly into retained earnings and not have this extra temporary
account? We could do this, but by having the Income Summary
account, you get a balance for net income a second time. This gives
you the balance to compare to the income statement, and allows you
to double check that all income statement accounts are closed and
have correct amounts.
The total debit to income summary should match total expenses from the income statement. Closing entries are journal entries posted at the end of an accounting period to reset temporary accounts to zero and transfer their balances to a permanent account known as retained earnings. Closing entries are those journal entries made in a manual accounting system at the end of an accounting period to shift the balances in temporary accounts to permanent accounts. Temporary accounts are used to compile transactions that impact the profit or loss of a business during a year, while permanent accounts maintain an ongoing balance over time. The first entry requires revenue accounts close to the Income Summary account.
- The next day, January 1, 2019, you get ready for work, but before you go to the office, you decide to review your financials for 2019.
- Otherwise, the balances in these accounts would be incorrectly included in the totals for the following reporting period.
- However, the cash balances, as well as the other balance sheet
accounts, are carried over from the end of a current period to the
beginning of the next period.
Answer the following questions on closing entries and rate your confidence to check your answer. Most organizations appear to be doing well on the surface while underlying accounting management issues silently sabotage. Lengthy accounting cycles and inaccurate projections can result in revenue leaks costing companies millions.
Which types of accounts do not require closing entries?
Instead, declaring and paying dividends is a method utilized by
corporations to return part of the profits generated by the company
to the owners of the company—in this case, its shareholders. Dividend account is credited to record the closing entry for dividends. Any remaining balances will now be transferred and a post-closing trial balance will be reviewed. 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.
Close all revenue and gain accounts
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. 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). 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).
Step 3: Closing the income summary account
The balance in the Income Summary account equals the net income or loss for the period. This balance is then transferred to the Retained Earnings account. After preparing the closing entries above, Service Revenue will now be zero.
The Income Summary balance is ultimately closed to the capital account. We’ll use a company called MacroAuto that creates and installs specialized exhaust systems for race cars. With the use of modern accounting software, this process often takes place automatically.
All accounts can be classified as either permanent (real) or
temporary (nominal) (Figure
5.3). Closing entries help in the reconciliation of accounts which facilitates in controlling the overall financials of a firm. It’s vital in business to keep a detailed record of your accounts. Answer the following questions on closing entries
and rate your confidence to check your answer. All accounts can be classified as either permanent (real) or temporary (nominal) (Figure 5.3).
The next day, January 1, 2019, you get ready for work, but before you go to the office, you decide to review your financials for 2019. What are your total expenses for rent, electricity, cable and internet, gas, and food for the current year? You have also not incurred any expenses yet for rent, electricity, cable, internet, gas or food. 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. 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. As part of the closing entry process, the net income (NI) is moved into retained earnings on the balance sheet.
Close all expense and loss accounts
You should recall from your previous material that retained earnings are the earnings retained by the company over time—not cash flow but earnings. Now that we have closed the temporary accounts, let’s review what the post-closing ledger (T-accounts) looks like for Printing Plus. The first entry closes revenue accounts to the Income Summary account. The second entry closes expense accounts to the Income Summary account.
Printing Plus has $100 of dividends with a debit balance on the adjusted trial balance. The closing entry will credit Dividends and debit Retained Earnings. The income summary account is an intermediary between revenues and expenses, and the Retained Earnings account. It stores all of the closing information for revenues and expenses, resulting in a “summary” of income or loss for the period.
The expense accounts and withdrawal account will now also be zero. 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. The income summary is used to transfer the balances of temporary accounts to retained earnings, which is a permanent account on the balance sheet. After this closing entry has been posted, each of these revenue accounts has a zero balance, whereas the Income Summary has a credit balance of $7,400.