When the time comes to make closing entries, an accountant will transfer all the balances in the temporary accounts to the Income Summary Account. This account works as a holding account for these balances so that the accountant can then make fewer entries to transfer the balance to the permanent accounts.
After all account balances for temporary accounts have been transferred and a zero balance remains in each , the income summary account should mirror your net income. Most often, this means transferring profit into the retained earnings account. Because the closing process relies on double-entry accounting, making closing entries means making a series of debits and credits to the appropriate accounts.
The first step will be to close out these accounts and transfer those temporary account balances to the income summary account through journal entries. For instance, you might have a cost of goods sold account and a utilities account. Consult your chart of accounts and make credits for each expense account. This brings us to zero balances in both the expense and revenue accounts. If any dividend payments need to be made, this is also when they are taken care of by debiting the retained earnings account and crediting the dividend account.
Of course, this process assumes that closing journal entries are made manually. For starters, accounting software can generate reports automatically based on the dates transactions are posted. Many businesses may opt to only close out those accounts at the end of the year and transfer the balance to the permanent accounts then.
Schedule a personalized demo today. ScaleFactor is on a mission to remove the barriers to financial clarity that every business owner faces. Accounting Cycle 1. Analyze Transactions 5. Prepare Adjusting Journal Entries 9. Prepare Closing Entries 2. Prepare Journal Entries 6. Post Adjusting Journal Entries Post Closing Entries 3. Post journal Entries 7. Prepare Adjusted Trial Balance Prepare Post-Closing Trial Balance 4. Prepare Unadjusted Trial Balance 8. Prepare Financial Statements Accounts are two different groups: Permanent — balance sheet accounts including assets, liabilities, and most equity accounts.
These account balances roll over into the next period. So, the ending balance of this period will be the beginning balance for next period. Temporary — revenues, expenses, dividends or withdrawals account.
These account balances do not roll over into the next period after closing. The closing process reduces revenue, expense, and dividends account balances temporary accounts to zero so they are ready to receive data for the next accounting period. The following video summarizes how to prepare closing entries. The four basic steps in the closing process are: Closing the revenue accounts —transferring the credit balances in the revenue accounts to a clearing account called Income Summary.
Closing the expense accounts —transferring the debit balances in the expense accounts to a clearing account called Income Summary. Closing the Income Summary account —transferring the balance of the Income Summary account to the Retained Earnings account. Closing the Dividends account —transferring the debit balance of the Dividends account to the Retained Earnings account.
Step 1: Close Revenue accounts Close means to make the balance zero. Debit Credit Service Revenue 36, Interest Revenue Income Summary 37, Step 2: Close Expense accounts The expense accounts have debit balances so to get rid of their balances we will do the opposite or credit the accounts.
Debit Credit Income Summary 37, — 28, 9, Retained Earnings 9, If expenses were greater than revenue, we would have net loss. Step 4: Close Dividends or withdrawals account After we add net income or subtract net loss on the statement of retained earnings, what do we do next? Retained earnings are those earnings not distributed to shareholders as dividends, but retained for further investment, often in advertising, sales, production, and equipment.
The income summary account serves as a temporary account used only during the closing process. It contains all the company's revenues and expenses for the current accounting time period.
In other words, it contains net income or the earnings figure that remains after subtracting all business expenses, depreciation, debt service expense, and taxes. The income summary account doesn't factor in when preparing financial statements because its only purpose is to be used during the closing process. Complete the closing entries using the following steps:. For most companies, this completes the accounting cycle for the current time period.
The four-step method described above works well because it provides a clear audit trail. For smaller businesses, it might make sense to bypass the income summary account and instead close temporary entries directly to the retained earnings account.
The end result is equally accurate, with temporary accounts closed to the retained earnings account for presentation in the company's balance sheet. In some cases, accounting software might automatically handle the transfer of balances to an income summary account, once the user closes the accounting period. The entries take place "behind the scenes," often with no income summary account showing in the chart of accounts or other transaction records.
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