Closing Entries: How to Prepare

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. The general journal is where businesses record their closing entries. The closing entries are then posted to the ledger accounts. The balance of the revenue account is cleared by applying a debit to the revenue account and an equivalent credit to the income summary account. The balances contained within these accounts will be deposited within the income summary account, which is itself a temporary account.

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State whether each account is a permanent or temporary account. It is the end of the year, December 31, 2018, and you are reviewing your financials for the entire year. You see that you earned $120,000 this year in revenue and had expenses for rent, electricity, cable, internet, gas, and food that totaled $70,000. This entry zeros out dividends and reduces retained earnings by total dividends paid.

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Aworksheetis a multiple-column form used in the adjustment process and in preparing financial statements. As its name suggests, the worksheet is a working Closing Entries: How to Prepare tool.It is not a permanent accounting record. The worksheet is merely a device used in preparing adjusting entries and the financial statements.

Closing Entries: How to Prepare

Closing entries transfer certain balances from accounts that will not transfer to the next period to permanent accounts. A general ledger is a record-keeping system for a company’s financial data, with debit and credit account records validated by a trial balance. If the balance in Income Summary before closing is a debit balance, you will credit Income Summary and debit Retained Earnings in the closing entry. If the balance in Income Summary before closing is a credit balance, you will debit Income Summary and credit Retained Earnings in the closing entry. Companies are required to close their books at the end of each fiscal year so that they can prepare their annual financial statements and tax returns. The income summary is a temporary account used to make closing entries.

Introduction to the Closing Entries

At the end of every period, temporary accounts must be set to a zero balance, and in order to do this, their balances will be deposited into the income summary account. The balances of the temporary accounts will end up being used to create the business’s income statement when the fiscal year ends. 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 is moved into retained earnings on the balance sheet. The assumption is that all income from the company in one year is held onto for future use. Any funds that are not held onto incur an expense that reduces NI. One such expense that is determined at the end of the year is dividends.

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In this article, we define what a closing entry on a balance sheet is, explain why it’s important, share some different types of closing entries and provide examples. A closing entry is a journal entry made at the end of accounting periodsthat involves shifting data from temporary accounts on the income statement to permanent accounts on the balance sheet.

How to Close an Expense Account

The revenue, expense, and dividend accounts are known as temporary accounts. They are called temporary because they are used temporarily to record activity for a specific period , and then they are closed into Retained Earnings. The revenue, expense, and dividend account balances from the current accounting period are set back to zero so accounting for the next period can begin. A center caption, Closing Entries, inserted in the journal between the last adjusting entry and the first closing entry, identifies these entries. Then the company posts the closing entries to the ledger accounts.

These permanent accounts show a company’s long-standing financials. The expense accounts have debit balances so to get rid of their balances we will do the opposite or credit the accounts.

How to Book a Loss to Retained Earnings

Janet Berry-Johnson is a CPA with 10 years of experience in public accounting and writes about income taxes and small business accounting. 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. All accounts can be classified as either permanent or temporary (Figure 5.3).

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