Closing Entry Definition, Explanation, and Examples

Explore how Wafeq can help your finance team implement accurate and secure closing entries, comply with audit requirements, and streamline your end-of-period processes. If the period is still unlocked, you can reverse or delete the closing journal entry. However, once the period is locked, no further changes can be made unless it is manually reopened by an authorized user.

What Is an Accounting Period?

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. As you will see later, Income Summary is eventually closed to capital. Let’s say Maria runs a small graphic design business called Maridesign.

Now that we know the basics of closing entries, in theory, let’s go over the step-by-step process of the entire closing procedure through a practical business example. Thus, the income summary temporarily holds only revenue and expense balances. After most of the cycle is completed and financial statements are generated, there’s one last step in the process known as closing your books. For partnerships, each partners’ capital account will be credited based on the agreement of the partnership (for example, 50% to Partner A, 30% to B, and 20% to C). For corporations, Income Summary is closed entirely to “Retained Earnings”.

How to Close an Accounting Period in Wafeq

This step initially closes all expense accounts to the income summary account, which is finally closed to the retained earnings account in the next step. This step initially closes all revenue accounts to the income summary account, which is further closed to the retained earnings account in step 3 below. After preparing the closing entries above, Service Revenue will now be zero.

• This involved reviewing, reconciling, and making sure that all of the details in the ledger add up.
• In the next accounting period, these temporary accounts are opened again and normally start with a zero balance.
• These accounts accumulate transactions throughout the period but must be reset to zero at the end of each accounting cycle.
• Once this has been completed, a post-closing trial balance will be reviewed to ensure accuracy.
• In just a few clicks, the entire financial year closing is streamlined for you.
• Net income is the portion of gross income that’s left over after all expenses have been met.

If these balances aren’t reset, the new period would carry over old data, distorting financial analysis. 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 (the accounting period), and then they are closed into Retained Earnings.

Consolidation & Reporting

This reduces retained earnings, representing the dividends distributed to shareholders during the period. Regardless of size or structure, closing entries are essential for accurate period-to-period financial reporting. By implementing automated closing processes, businesses ensure greater accuracy while freeing valuable resources for strategic financial activities. Remember that all revenue, sales, income, and gain accounts are closed in this entry. Do you want to learn more about debit, credit entries, and how to record your journal entries properly? Then, head over to our guide on journalizing transactions, with definitions and examples for business.

Closing Entry

The balance in dividends, revenues and expenses would all be zero leaving only the permanent accounts for a post closing trial balance. 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. We do not need to show accounts with zero balances on the trial balances. All temporary accounts must be reset to zero at the end of the accounting period. To do this, their balances are emptied into the income summary account.

All temporary accounts with a debit balance, particularly the expense accounts, are credited while the income and expense summary account is debited. In this first step, you transfer all income account balances to an income summary account. This clears the revenue accounts to zero and prepares them for the next period.

Step 4: Close withdrawals to the capital account

These accounts are zeroed out and moved into a permanent account called retained earnings (or sometimes into an income summary account first). Closing entries have a direct impact on the balance sheet, as they transfer temporary account balances to permanent accounts. The balance sheet captures a snapshot of a company’s financial position at a given point in time, and closing entries help to ensure that the balance sheet accurately reflects the company’s financial position. Closing entries, also called closing journal entries, are entries made at the end of an accounting period to zero out all temporary accounts and transfer their balances to permanent accounts. In other words, the temporary accounts are closed or reset at the end of the year. The timing of closing entries is crucial for ensuring accurate financial reporting.

• Close Expense Accounts to Income SummaryEach expense account is credited (to zero its balance), and the total is debited to the Income Summary account.
• Notice how only the balance in retained earnings has changed and it now matches what was reported as ending retained earnings in the statement of retained earnings and the balance sheet.
• As mentioned, one way to make closing entries is by directly closing the temporary balances to the equity or retained earnings account.
• If it is a corporation, then it should be closed to the retained earnings account.
• When dividends are declared by corporations, they are usually recorded by debiting Dividends Payable and crediting Retained Earnings.

These accounts are closed at the end of the year and do not carry forward into the next period. Next, you do the same with your expenses by adding up everything you spent on supplies, rent, marketing, and so on. If your total expenses were $70,000, you’d debit the income summary and credit your expense account. You then take that final number and shift it over to your retained earnings, basically the company’s “savings” account. So if you had a profit of $30,000, that gets added to your retained earnings; if it was a loss, the amount comes out of it. To close out your books at the end of the year (or month), you start by clearing out your revenue accounts.

Close all dividend or withdrawal accounts

This process occurs after all regular transactions have been recorded and adjusting entries have been made for the accounting period. This ensures that the company’s financial performance is accurately reflected in the financial statements. A closing entry is a bookkeeping record that moves data from the last accounting period to the company’s permanent record.

Assets, liabilities, common stock, and retained earnings are not closed at the end of the period because they are not used to measure activity for only one specific period. As the next accounting period starts, reopen the permanent accounts by placing their balance to their normal sides. After all income statement accounts are closed to the income and expense summary account, the latter’s balance will determine whether there is net income or net loss. It’s easier to measure and track revenues and expenses during the period when the accounts start with a clean slate. This ensures that the income earned and expenses incurred so far pertains only to that period and does not include cumulative data from previous periods.

It’s not necessarily a process meant for the faint of heart because it involves identifying and moving numerous data from temporary to permanent accounts on the income statement. The closing entry entails debiting income summary and crediting retained earnings when a company’s revenues are greater than its expenses. The income summary account must be credited and retained earnings reduced through a debit in the event of a loss for the period. In summary, the closing process only applies to temporary accounts found in the income statement. Accounts in the statement of financial position are permanent and their balances will not be closed at the end of an accounting period, unless the company stops using the account or ceases its operations.

Instead, the basic closing step is to access an option in the software to close the reporting period. Doing so automatically populates the how to value noncash charitable contributions retained earnings account for you, and prevents any further transactions from being recorded in the system for the period that has been closed. The income summary is used to transfer the balances of temporary accounts to retained earnings, which is a permanent account on the balance sheet. First, all the various revenue account balances are transferred to the temporary income summary account. This is done through a journal entry that debits revenue accounts and credits the income summary. Closing entries are journal entries made at the end of an accounting period, that transfer temporary account balances into a permanent account.

These entries also help align retained earnings with the company’s actual net income. Every business in existence needs to close the books at the end of the accounting period, and the closing entry is the endpoint that wraps everything up. Whether it’s monthly, quarterly, or annually, there’s a process that ensures all the revenue and expenses are tallied up, and that’s where closing entries come in. Without them, the numbers don’t reset, and financial reports start piling on top of each other like an overstuffed inbox. The purpose of closing the books is to prepare the ledger accounts for recording the transactions of the next period.