The trial balance shows the ending balances of all asset, liability and equity accounts remaining. The main change from an adjusted trial balance is revenues, expenses, and dividends are all zero and their balances have been rolled into retained earnings. A closing entry is a journal entry that is made at the end of an accounting period to transfer balances from a temporary account to a permanent account. We see from the adjusted trial balance that our revenue accounts have a credit balance.

Step 1: Close all income accounts to Income Summary

And so, the amounts in one accounting period should be closed so that they won’t get mixed with those in the next period. As you will see later, Income Summary is eventually closed to capital. Prepaid Expense is where the Expense is paid in advance before the expense transaction even happens; since it is paid beforehand, the account is viewed as an asset account.

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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 general journal is used to record various types of accounting entries, including closing entries at the end of an accounting period. To close the drawing account to the capital account, we credit the drawing account and debit the capital account. To close expenses, we simply credit the expense accounts and debit Income Summary. To close that, we debit Service Revenue for the full amount and credit Income Summary for the same. The income summary is a temporary account used to make closing entries.

Step 3 – closing the income summary account:

The T-account summary for Printing Plus after closing entries are journalized is presented in Figure 5.7. Printing Plus has a $4,665 credit balance in its Income Summary account before closing, so it will debit Income Summary and credit Retained wave accounting review Earnings. The income statement summarizes your income, as does income summary. If both summarize your income in the same period, then they must be equal. We at Deskera offer the best accounting software for small businesses today.

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Notice that there are no longer income statement accounts present. The updated balance of the owner’s capital is now $510,520 after adding the net income of $128,520. Once this entry is posted, the income summary account will have a credit balance of $322,520. The $9,000 of expenses generated through the accounting period will be shifted from the income summary to the expense account. A business will use closing entries in order to reset the balance of temporary accounts to zero. Permanent (real) accounts are accounts that transfer balances to the next period and include balance sheet accounts, such as assets, liabilities, and stockholders’ equity.

1. The above entry increases the balance of retained earnings account.
2. If you own a sole proprietorship, you have to close temporary accounts to the owner’s equity instead of retained earnings.
3. The use of closing entries resets the temporary accounts to begin accumulating new transactions in the next period.
4. The following steps need to be taken to close the temporary accounts.

Closing entries are put into action on the last day of an accounting period. There are various journals for example cash journal, sales journal, purchase journal etc., which allow users to record transactions and find out what caused changes in the existing balances. Closing entries are mainly used to determine the financial position of a company at the end of a specific accounting period. After the closing journal entry, the balance on the drawings account is zero, and the capital account has been reduced by 1,300. The retained earnings account is reduced by the amount paid out in dividends through a debit and the dividends expense is credited.

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Our discussion here begins with journalizing and posting the closing entries (Figure 5.2). These posted entries will then translate into a post-closing trial balance, which is a trial balance that is prepared after all of the closing entries have been recorded. Any account listed on the balance sheet is a permanent account, barring paid dividends.

These accounts have continuous balances that carry forward from one accounting period to another. Examples of accounts not affected by closing entries include asset, liability, and equity accounts. You need to create closing journal entries by debiting and crediting the right accounts.

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. The closing entry will debit both interest revenue and service revenue, and credit Income Summary. This means that it is not an asset, liability, stockholders’ equity, revenue, or expense account. The account has a zero balance throughout the entire accounting period until the closing entries are prepared.

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If your revenues are greater than your expenses, you will debit your income summary account and credit your retained earnings account. Clear the balance of the expense accounts by debiting income summary and crediting the corresponding expenses. On the statement of retained earnings, we reported the ending balance of retained earnings to be $15,190. Temporary accounts are accounts in the general ledger that are used to accumulate transactions over a single accounting period.

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. 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. 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).

At the end of the year, all the temporary accounts must be closed or reset, so the beginning of the following year will have a clean balance to start with. In other words, revenue, expense, and withdrawal accounts always have a zero balance at the start of the year because they are always closed at the end of the previous year. Failing to make a closing entry, or avoiding the closing process altogether, can cause a misreporting of the current period’s retained earnings. It can also create errors and financial mistakes in both the current and upcoming financial reports, of the next accounting period. Expense accounts have a debit balance, so you’ll have to credit their respective balances and debit income summary in order to close them. As mentioned, one way to make closing entries is by directly closing the temporary balances to the equity or retained earnings account.

Printing Plus has $100 of supplies expense, $75 of depreciation expense–equipment, $5,100 of salaries expense, and $300 of utility expense, each with a debit balance on the adjusted trial balance. The closing entry will credit Supplies Expense, Depreciation Expense–Equipment, Salaries Expense, and Utility Expense, and debit Income Summary. The income summary account is a temporary account solely for posting entries during the closing process.

During the process of closing accounts, there are multiple steps and information that you must remember. If not followed precisely, it would cause a misreport of a very important Account. In Accounting, Closing Entries are the same in every accounting standard worldwide except for some minor details. Countries may have extra steps or fewer steps when closing their entries, but generally, it is all the same where Temporary Accounts are closed and the balances are transferred. Temporary accounts can either be closed directly to the retained earnings account or to an intermediate account called the income summary account. The income summary account is then closed to the retained earnings account.

Income summary effectively collects NI for the period and distributes the amount to be retained into retained earnings. Balances from temporary accounts are shifted to the income summary account first to leave an audit trail for accountants to follow. Permanent accounts track activities that extend beyond the current accounting period. They’re housed on the balance sheet, a section of financial statements that gives investors an indication of a company’s value including its assets and liabilities. Closing entry is a process where all temporary accounts opened in the fiscal year are transferred and closed to a permanent arrangement. Doing so will give zero balance to the brief history to use for the next fiscal year.

Most organizations appear to be doing well on the surface while underlying accounting management issues silently sabotage. Notice that the balance https://www.business-accounting.net/ of the Income Summary account is actually the net income for the period. Remember that net income is equal to all income minus all expenses.

You can report retained earnings either on your balance sheet or income statement. Without transferring funds, your financial statements will be inaccurate. A worksheet is a tool that helps you organize and summarize the information needed for closing entries. It consists of several columns that show the trial balance, adjustments, adjusted trial balance, income statement, and balance sheet. All expense accounts will be zero, and the expenses account will be closed, by crediting the expenses account and debiting the income summary account. All revenue accounts will be zero after debiting the revenue account and crediting the income summary account, and the revenue account will be closed at the same time.