Closing Entries Financial Accounting - Daddy Tv

Income Summary allows us to ensure that all revenue and expense accounts have been closed. However, some corporations use a temporary clearing account for dividends declared (let’s use “Dividends”). They’d record declarations by debiting Dividends Payable and crediting Dividends. If this is the case, then this temporary dividends account needs to be closed at the end of the period to the capital account, Retained Earnings. When dividends are declared by corporations, they are usually recorded by debiting Dividends Payable and crediting Retained Earnings.

Recording a Closing Entry

If you have only done journal entries and adjusting journal entries, the answer is no. Let’s look at the trial balance we used in the Creating Financial Statements post. Think about some accounts that would be permanent accounts, like Cash and Notes Payable. While some businesses would be very happy if the balance in Notes Payable reset to zero each year, I am fairly certain they would not be happy if their cash disappeared. Assets, liabilities and most equity accounts are permanent accounts.

What Is a Closing Entry?

In other words, the income and expense accounts are “restarted”. You need to use closing entries to reduce the value of your temporary accounts to zero. That way, your next accounting period does not have a balance in your revenue or expense account from the previous period. The income summary account is a temporary account that the company uses at the end of the accounting period to transfer the resulting the ins and outs of asset of net income or net loss to the retained earnings account. The company can make the closing entry for expenses by debiting the income summary account and crediting all expenses accounts. Additionally, it is important to note that the income summary account plays both roles of the debit and the credit at the same time when the company closes the income statement at the end of the period.

What are Temporary Accounts?

Closing the income summary account is done after all income sources are accounted as retained earnings of the organization. But before that entry is passed, there are a few steps to the process. In a sole proprietorship, a drawing account is maintained to record all withdrawals made by the owner. In a partnership, a drawing account is maintained for each partner.

Example of Closing Entries

The net balance of the income summary account is closed to the retained earnings account. The net amount transferred into the income summary account equals the net profit or net loss that the business incurred during the period. Thus, shifting revenue out of the income statement means debiting the revenue account for the total amount of revenue recorded in the period, and crediting the income summary account. At the end of each accounting period, all of the temporary accounts are closed. This way each accounting period starts with a zero balance in all the temporary accounts, so revenues and expenses are only recorded for current years.

Note that by doing this, it is already deducted from Retained Earnings (a capital account), hence will not require a closing entry. Take note that closing entries are prepared only for temporary accounts. Close the income summary account by debiting income summary and crediting retained earnings. You need to create closing journal entries by debiting and crediting the right accounts. Use the chart below to determine which accounts are decreased by debits and which are decreased by credits. Now that the journal entries are prepared and posted, you are almost ready to start next year.

• Closing the income summary account is done after all income sources are accounted as retained earnings of the organization.
• Closing entries are entries used to shift balances from temporary to permanent accounts at the end of an accounting period.
• Now for this step, we need to get the balance of the Income Summary account.
• Doing so automatically populates the retained earnings account for you, and prevents any further transactions from being recorded in the system for the period that has been closed.
• One such expense that’s determined at the end of the year is dividends.

The income summary is a temporary account used to make closing entries. Debit the company’s revenue account for the balance in the revenue account. For instance, a company with a $10,000 balance in revenue must debit revenue for $10,000.

For corporations, Income Summary is closed entirely to “Retained Earnings”. The Income Summary balance is ultimately closed to the capital account. 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. Prepare closing entry for the net income of the company ABC above.

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. Now that Paul’s books are completely closed for the year, he can prepare the post closing trial balance and reopen his books with reversing entries in the next steps of the accounting cycle. It is also commonly found that an income summary is confused with an income statement.

My Accounting Course  is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers. Shaun Conrad is a Certified Public Accountant and CPA exam expert with a passion for teaching. After almost a decade of experience in public accounting, he created MyAccountingCourse.com to help people learn accounting & finance, pass the CPA exam, and start their career.